SECURE ACT—Impact on Inherited Retirement Accounts

SECURE Act Included in Year-end Legislation, Implements New Retirement Plan Provisions

The Setting Every Community Up for Retirement Enhancement Act (the SECURE Act), which was enacted on December 20, 2019 (H.R. 1994), makes sweeping changes to the rules governing retirement plans. Those changes include adding a fiduciary safe harbor for the selection of a lifetime-income provider, requiring employers to permit long-term part-time employees to participate in retirement plans, and allowing multiple-employer plans to be structured among employers without a common interest.

SECURE Act Provisions

Effective Upon Enactment

Fiduciary safe harbor: The SECURE Act adds a safe harbor to the Employee Retirement Income Security Act (ERISA), easing uncertainties for plan fiduciaries offering an annuity as an investment option in a defined contribution plan. If the safe harbor is satisfied, plan fiduciaries are deemed to have met ERISA's prudence standard as to the selection of an insurer of the plan's annuity option and are not liable for losses resulting from the insurer's inability to satisfy its financial obligations under the contract.

Relief from nondiscrimination rules: The SECURE Act permits certain defined benefit plans with features that are closed to new participants to meet nondiscrimination, minimum coverage, and minimum participation rules by cross-testing the benefits with the sponsor's defined contribution plans. The relief is limited to plans closed as of April 5, 2017, or that have been in operation and made no substantial increases to the coverage or value of benefits of the closed class for five years preceding the closure. Although the changes are generally effective upon enactment, plan sponsors may elect to apply the changes to plan years beginning after December 31, 2013.

Beginning in 2020

Repeal of maximum age for traditional IRA contributions: Effective for tax years beginning after December 3, 2019, the SECURE Act repeals the limitation on traditional IRA contributions for individuals over age 70½. Provided other requirements (such as having earned income) are met, these individuals may continue contributing to a traditional IRA. Permitted charitable contributions are reduced by post-70½ contributions.

Portability of lifetime income options: Generally, qualified plans may not distribute to participants who are still working for the plan sponsor. Effective for plan years beginning after December 31, 2019, the SECURE Act adds a new exception from this prohibition, allowing plan participants of defined contribution plans, IRC Section 403(b) plans, or governmental IRC Section 457(b) plans to make direct trustee-to-trustee transfers, or transfer annuity contracts, of lifetime income investments that are no longer authorized to be held as an investment option under the plan.

Increasing the required minimum distribution (RMD) age: Participants generally must begin taking required minimum distributions from their retirement plan at a specified age. Effective for tax years beginning after December 31, 2019, the SECURE Act increases the specified age from 70½ to 72.

Limitations on inherited IRAs. Under prior law, distributions from qualified defined contribution plans generally had to begin within one year of the employee's death and be paid out over the life expectancy of the designated beneficiary. If the beneficiary was a non-spouse designated individual beneficiary, such as a child, the payout could be effectively "stretched" over the longer life expectancy of the designated beneficiary, significantly deferring taxation. Because similar rules applied to IRAs, the "stretch IRA" has been a common estate-planning technique.

Effective for deaths of an IRA owner or defined contribution plan participant occurring after 2019, the individual beneficiary must draw down the inherited interest within 10 years. The rule allows an exception for an eligible designated beneficiary, which includes any beneficiary who is (i) the surviving spouse, (ii) a child under the age of majority (the 10-year rule would apply as of the date of majority), (iii) disabled or chronically ill, or (iv) no more than 10 years younger than the plan participant or IRA owner.

Increasing the auto-enrollment safe harbor cap: Certain 401(k) plans qualify for a safe harbor that deems the plan to satisfy the automatic deferral percentage requirement of the nondiscrimination rules, provided that the plan treats employees as making elective deferrals at specified rates unless the employee elects otherwise. Under prior law, such an automatic enrollment safe harbor plan could not set a default contribution rate higher than 10% of the employee's compensation. Effective for plan years beginning after December 31, 2019, the SECURE Act allows the default rate to increase from 10% to 15% after the first year of participation.

Changes to nonelective safe harbor 401(k) plans: IRC Section 401(k) plans may avoid nondiscrimination testing by adopting a safe harbor structure under which specified matching or nonelective contributions are made. Among other things, safe harbor plans must satisfy certain notice requirements. Effective for plan years beginning after December 31, 2019, safe harbor plans relying on nonelective contributions have additional flexibility in satisfying these notice requirements. Specifically, nonelective safe harbor 401(k) plans no longer have to provide a safe harbor notice, provided that the employee still has an effective opportunity to make or change elections at least once a year. Additionally, a plan sponsor may adopt a nonelective safe harbor 401(k) plan during the year by (1) retroactively amending the plan at any date before the 30th day before the close of the plan year; or (2) amending the plan at a later date if the plan is amended to provide for a nonelective contribution of at least 4% of compensation for all eligible employees and the amendment is made by the last day for distributing excess contributions for the plan year.

Increased penalty for failure to file retirement plan returns: Applicable for returns, statements, notifications, and notices required to be filed or provided after December 31, 2019, the SECURE Act increases certain penalties. The penalty for failing to file a Form 5500 increases from $25 per day to $250 per day (not to exceed $150,000). The penalty for failure to file a registration statement for separated, deferred vested participants increases from $1 to $10 per participant per day (not to exceed $50,000). Similarly, the penalty for failure to file a required notification of certain changes in a plan's registration information increases from $1 to $10 per day (up to $10,000) for the length of the failure. The penalty for failing to provide a required withholding notice increases from $10 to $100 per failure (not to exceed $50,000 per year).

Beginning in 2021

Facilitation of open multiple-employer plans: A multiple-employer plan (MEP) is a plan (that is not a collectively bargained Taft-Hartley plan) maintained by two or more unrelated employers. Historically, Department of Labor (DOL) rules permitted a MEP to be established only by a cognizable, bona fide group or association sharing a common interest. This year, the DOL expanded this rule, allowing looser affiliations to satisfy the common interest requirement.

Under prior law, if just one participating employer failed to satisfy the plan qualification rules, the entire MEP was subject to disqualification. The Treasury Department and the IRS recently proposed rules providing limited relief from this result. The SECURE Act goes further than these new administrative changes, codifying rules, effective for plan years beginning after December 31, 2020, that allow unrelated small employers with no common interest to create MEPs. Further, these rules protect the MEP from disqualification if one employer in the MEP fails to meet the qualification requirements.

Making long-term part-time employees eligible for retirement plan participation: Under prior law, 401(k) plans could exclude employees who had not completed 1,000 hours of service over 12 months. Effective for plan years beginning after December 31, 2020, the SECURE Act now requires 401(k) plans (except collectively bargained plans) to allow participation by an employee who either satisfies the 1,000-hour rule or completes at least 500 hours of service in each of three consecutive years. For employees qualifying solely under the latter rule, employers are not required to make nonelective or matching contributions and may elect to exclude these employees from testing under nondiscrimination and coverage rules, and from application of the top-heavy rules.

Beginning in 2022

Combined annual reports for group of defined contribution plans: Effective for plan years beginning after December 31, 2021, DOL and Treasury are directed to effectuate filing of consolidated Form 5500 for defined contribution plans, provided the plans have the same trustee, named fiduciary, and administrator; use the same plan year; and provide the same investment options to participants and beneficiaries.

Future

Disclosure of lifetime income: Effective more than 12 months after the latest of the DOL's issuance of interim final rules, the model disclosure, or the assumptions upon which notices are based, plan administrators must include a lifetime-income disclosure with defined contribution plan benefit statements. This new disclosure will convert a participant's current account balance into a monthly annuity at retirement age. By December 20, 2021, the DOL must issue a model lifetime income disclosure and prescribe assumptions that may be used in converting participant account balances to lifetime income-stream equivalents. No plan fiduciary, plan sponsor, or other person will be liable under ERISA for lifetime income-stream equivalents derived from DOL's model disclosures and assumptions.

The SECURE Act also includes the following changes:

Implications

The SECURE Act makes numerous legislative changes, many of which are already effective, to qualified retirement plans. These changes, which enjoyed remarkably broad bipartisan support among lawmakers and retirement industry groups, ease certain administrative burdens on employers, encourage plan participation, and incentivize workers to save for retirement.