The Setting Every Community Up for Retirement Act (SECURE Act) is officially becoming a law. This comes after years of American workers staring down the barrel of a retirement crisis. A 2018 U.S. Bureau of Labor Statistics study shows that 55% of American workers participate in employer sponsored retirement plans, and the majority of those who do are woefully behind in saving. The average 65-year-old’s 401(k) balance is just $58,035. With many Americans ineligible for a pension, the lack of adequate 401(k) saving gives cause for alarm.
The U.S. Congress’ remedy for this calamity is the Setting Every Community Up for Retirement Act, which President Trump officially signed into law on December 20, 2019. There are many underlying aspects of this legislation to be aware of, including increasing access to 401(k) plans, the promotion of lifetime income options and providing of incentives for businesses to create new retirement plans. Congress intends these changes to boost 401(k) participation and, through the following reforms, prevent future retirees from running out of money in old age.
This article will specifically examine the 401(k) plan changes to come from the SECURE law. Here is what every American should know.
Tax Credits for Small Business
According to a recent Pew study, the top reason why small businesses do not sponsor a 401(k) plan today is cost. Higher tax credits may promote better implementation and utilization of corporate sponsored retirement plans. Before the SECURE Act, a small business (up to 100 employees) could claim a tax credit equal to 50% of their retirement plan startup costs, up to a $500 limit. Now, the limit is the greater of (1) $500 or (2) the lesser of (a) $250 multiplied by the number of non-highly compensated employees eligible for plan participation or (b) $5,000. This credit is available for up to three years
Small businesses can earn an additional $500 tax credit by adding an automatic enrollment feature to a new or existing 401(k) plan. The credit is available for each of the first three years the feature is effective.
Clarifications to Multiple Employer Pans (MEP’s)
While MEP’s already existed prior the law change, there were many concerns about how the DOL viewed them. With the passage of the SECURE Act those concerns were removed. The SECURE act created Pooled Employer Plans (PEPs) – a form of “open” Multiple Employer 401(k) Plan (MEP) that any employer can join. MEP supporters claim PEPs will offer two key advantages over traditional single-employer 401(k) plans: lower fees for retirement savers and liability protection for employers.
- Economies of scale – Through gathering the 401(k) assets of multiple employers, supporters claim MEPs can offer lower fees and higher quality services to small employers with fewer 401(k) assets due to “economies of scale.” Years of falling prices and “fee compression” has forced many plan providers to lower costs. The MEP provides another channel with some additional benefit.
- Reduced fiduciary liability – Employers must meet certain fiduciary responsibilities to protect the interests of their 401(k) plan participants. When employers join a MEP, they delegate many (if not all) of their fiduciary responsibilities to the MEP provider – a Pooled Plan Provider (PPP) in the case of a PEP. This delegation can sound like an easy way for employers to reduce their fiduciary liability until you understand that 401(k) fiduciary responsibilities include a duty to “monitor” plan service providers or ensure they’re doing a competent job for reasonable fees.
New Plan Adoption Deadline
The SECURE law will also impact the deadline for employers to establish a new 401(k) plan. It extends this date from the last day of the tax year to the due date of the year’s tax return (including extensions).
Changes To 401(K) Plan Eligibility for Certain EmployeesPrior to the SECURE Act, 401(k) plans could exclude part-time employees who worked less than 1,000 hours per year (19.23 hours per week). Under the new legislation, plans must extend eligibility to all employees who worked at least 500 hours per year in the preceding three 12-month periods.
The law stops short of requiring matching contributions for part-time employees made eligible by the Act. It does, however, require stricter standards for the plan to pass nondiscrimination testing, which ensures plans are fair to lower-level employees.
Plan administrators can bypass this stricter nondiscrimination testing by mandating a 3% nonelective contribution. Non-elective contributions are fully paid by the employer, and they are not matching contributions. Instead, a flat 3% of employees’ salaries must be contributed.
Employers must implement the 3% nonelective contribution at least 30 days prior to the plan year’s close. The Act allows for later implementation to count toward the nondiscrimination testing exception if contributions of at least 4% are made by the plan year’s end.
Changes for Lifetime Income Options in Defined Contribution PlansDefined contribution plans have helped millions of Americans build a secure retirement, but as the grim statistics regarding retirement preparedness show, they have their disadvantages. One serious drawback is a market retrenchment in the years before retirement. As seen in the 2008 financial crisis, the markets need several years to recover from a major setback. This is a dire problem if you plan to retire when markets are depressed by nearly 50%.
Retirees can insure against this risk by placing part of their nest egg in lifetime income options, such as annuities, in which an insurance company guarantees principal preservation.
The SECURE Act encourages the purchase of lifetime income options by requiring plans to include their estimated retirement income in annual benefit statements. Statements must show potential income from joint, survivor and single-life annuity products.
This provision takes effect one year after the Department of Labor releases model disclosures and assumptions for calculating income estimates.
Limited Liability If Plan Provides Lifetime Income OptionsThe Act does not require employers to provide lifetime income options, only to disclose their income. However, it does incentivize employers to include them by limiting plan sponsor liability.
Prior to the SECURE Act, plan sponsors had reason to shy away from including lifetime income options in a 401(k) plan. What if the insurance company offering the annuities became unable to fulfill its financial obligations sometime in the faraway future? The company could face liability to plan participants who lost their savings. This created a liability trap extending far beyond the foreseeable future.
Now companies are free to offer lifetime income options without fear of open-ended liability. Fulfilling their fiduciary obligation requires verifying the insurer’s financial capability at the time of selection and ensuring costs or fees are reasonable. If the plan sponsor performs these tests appropriately, it has no liability for future changes in the insurer’s financial status that cause it to default on annuities issued to plan participants.
Change to Plan Distribution RulesPrior to the SECURE Act, plan participants had to take required minimum distributions (RMD) by April 1 of the year after reaching the age of 70 ½. The Act increases the RMD maximum age to 72, though plan sponsors remain free to set an earlier RMD age. The change applies to all plan participants who turn 70 ½ after December 31, 2019. As a result, many plan participants can now build extra savings.
Increased retirement savings are key to preventing a full-blown crisis as workers retire over the next several decades. The SECURE Act reforms increase employer incentives to offer plans, expand the eligibility pool, encourage non-elective contributions and promote lifetime income options. By implementing these changes, employers can help their workers aim for a secure and abundant retirement.
Safe harbor 401(k) plans
The following changes apply to safe harbor 401(k) plans that employ a nonelective contribution (not a match):
- Eliminates the annual safe harbor notice requirement
- Permits a 401(k) plan to add a 3% safe harbor nonelective contribution at any time up to 30 days before the close of the plan year.
- Permits a 401(k) plan to add a safe harbor nonelective contribution after the 30th day before the close of the plan year when 1) the amendment to adopt safe harbor 401(k) status is made by the end of the following plan year (the deadline for distributing ADP/ACP corrective refunds) and 2) the nonelective contribution is at least 4%.
All changes are effective for plan years beginning after December 31, 2019.
QACA automatic enrollment
The default contribution limit for a Qualified Automatic Contribution Arrangement (QACA) safe harbor 401(k) plan is increased from 10% to 15% following a participant’s first year of plan participation. The 10% limit still applies for the first year of participation. This change is effective for plan years beginning after December 31, 2019.
Stay Educated & Plan for A Better Retirement
With all the newly introduced 401(k) implications of the SECURE law it is most important to stay educated on how these changes will specifically affect a person’s individual retirement plan. As the most important piece of retirement legislation in years, the SECURE law will affect everyone’s retirement planning process, whether it is five, ten or twenty years down the line. Take the necessary precautions now to understand how the SECURE law will most likely affect your plan.
This information is not intended as authoritative guidance or tax or legal advice. You should consult your attorney or tax advisor for guidance on your specific situation.
Brian Menickella is a co-founder and managing partner of The Beacon Group of Companies, a broad-based financial services firm based in King of Prussia, Pa.