Winter 2019/2020 Fiduciary Commentary
By: Brant Griffin, February 28, 2020
The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, the most comprehensive change to the retirement system since the Protection Act (PPA) of 2006, was signed into law by President Trump on December 20, 2019. The SECURE Act addresses many of the long-overdue, needed updates to the retirement system, and represents a broad effort to expand opportunities for savers.
The law is the result of a multi-year, bipartisan process and was championed by many key lawmakers on both sides of the aisle. The bill includes many of the elements of the Senate’s 2018 legislation Retirement Enhancement and Savings Act (RESA) that was approved by the Finance Committee but never went to a full vote. The new law’s major area of focus includes three key facets of retirement plans: expanding access to plans and encouraging savings, encouraging lifetime income investments, and modifying required minimum distribution (RMDs) rules. This legislation affects defined contribution plans, defined benefit plans, IRA accounts, and Section 529 College Savings Accounts.
Promoting Lifetime Income Feature from Retirement Plans
The concept of lifetime income has been a topic of conversation in defined contribution circles for what seems the better part of a decade, yet nothing has come to pass. Plan sponsors have long voiced support for guaranteed income products as a powerful plan tool to ensure plan participants don’t outlive their retirement savings. Despite this, fears surrounding the fiduciary risk of the selection and monitoring of the products and insurance companies that provide the guaranteed investment products have thwarted plan sponsors from adding the investments to their plans. The SECURE Act addresses these fiduciary concerns and promotes the use of guaranteed investment alternatives in qualified retirement plans.
- Fiduciary Safe Harbor for Selection of Lifetime Income Provider: The SECURE Act creates a new fiduciary safe harbor for employers when selecting an insurance company to offer a group annuity as a plan investment.
- Lifetime Income Portability: The Act requires the portability of the annuity investments. If an annuity offering is removed from a plan, participants will be permitted to take a distribution of the investment to an IRA or another defined contribution plan.
- Lifetime Income Disclosures: The law mandates that the DOL standardize the way participants lifetime income is reported.
Plan sponsors are not expected to adopt annuity products in the near term. However, North Pier does anticipate some product development in this category if demand materializes. Offerings could take the shape of either standalone lifetime income solutions or annuity products incorporated into target-date funds.
Rules Affecting Those at or Near Retirement
An immediate impact of the SECURE Act will be felt by those near or in retirement. Among the provisions affecting retired persons are increased savings opportunities and provisions that modify the required minimum distribution rules.
- Increased Savings Opportunities: Contributions to IRA accounts prior to the SECURE Act were not permitted after age 70½. Acknowledging increasing lifespans and longer working years, the new law permits those still working and with earned income to make an IRA contribution beyond the age of 70½, allowing for additional savings opportunities and valuable tax deductions. This rule change aligns IRA rules with those of qualified plans.
- Age for Required Beginning Date for RMDs: Increases the age at which required minimum distributions must begin from 70½ to 72. The change is effective for distributions after December 31, 2019, for individuals who turn 70½ after that date.
- Required Minimum Distribution Rules: Previously, if you were the beneficiary of a retirement account, you were permitted to take distributions from the account over your life expectancy (stretch payments). Beginning on January 1, 2020, The SECURE Act now requires most non-spouse beneficiaries to withdraw assets from an inherited retirement account within ten years following the death of the account owner. Spousal, minor children, and disabled or chronically ill beneficiaries are exceptions to the 10-year rule. The elimination of the “stretch” estate planning strategy may have a major impact on estate plans and necessitate a review of beneficiary selections and estate arrangements.
From a participant perspective, many of these plan changes affect long-term financial and tax planning strategies. It will be important for participants to consider how the Act will impact their overall financial and estate plans.
Incentives to Adopt Employer-Sponsored Retirement Plans
Qualified plans are perceived as expensive and complex to administer. With approximately half of the US workforce not covered by an employer retirement plan, incentives provided by the new law provide a powerful financial inducement to adopt new employer savings plans.
- Small Employer Plan Start-Up Credit: The Act increases the tax credit provided to small employers to adopt an employer plan. Startup retirement plans are eligible for a tax credit of $250 per non-highly compensated employee or $500, the greater of the two up to a maximum of $5,000. The credit would apply to employers with 100 or fewer employees over a 3-year period beginning after December 31, 2019, provided that they haven’t had any employer plan for the proceeding three years. The credit applies to SEP, SIMPLE, 401(k), and other profit-sharing types of plans. An additional credit of up to $500 is available to those plans that include an automatic enrollment feature.
- Pooled Employer Plans: The law permits unrelated employers to combine resources and adopt a MEP or Multiple Employer Plan. These pooled employer plans allow smaller employers to potentially benefit from better pricing and a more robust set of plan features from the economies of scale of multiple employers’ plan assets. Additionally, the bill addresses a previous downside of these plans by providing relief from the “one-bad-apple” rule that all the employers would be subject to adverse tax consequences if one employer failed to satisfy the qualification rules for the MEP.
- Plan Adoption Date: An employer is now permitted to adopt a qualified retirement plan up to the tax filing deadline of the employer’s tax return plus extensions.
Other Changes to Retirement Plans
- Penalty-Free Withdrawals for Qualified Birth or Adoption: The law allows penalty-free (10% early withdrawal penalty will not apply) distribution from retirement plans for the birth or adoption of a child. The distribution amount allowed is up to $5,000 per child up to a total of $10,000.
- Long-Term Part-Time Employees: Except for collectively bargained plans, the new bill requires 401(k) plans to allow participation by long-term, part-time employees who work at least 1000 hours in one year or 500 hours for three consecutive 12-month periods.
- Increase on Automatic Enrollment Safe Harbor Default Rate: Currently, the Qualified Automatic Contribution Arrangement (QACA) for safe harbor 401(k) may not automatically enroll or escalate employee contributions above 10% of the employee’s eligible compensation. The SECURE Act encourages additional retirement savings by increasing the automatic deferral rates to 15 percent in year two (the current maximum rate of 10% holds for the first year) for the automatic enrollment safe harbor 401(k) plan nondiscrimination rules limit to be met.
- Simplifies nonelective 401(k) Safe Harbor Notices: The law simplifies safe harbor 401(k) rules by (1) eliminating the notice requirement for safe harbor plans that satisfy the plan rules by making nonelective contributions to their employees and (2) allowing an amendment to add safe harbor nonelective contributions to plans mid-year.
- Payment of Student Loan Debt from 529 Plans: The law expands the definition of qualified education expenses to include student loan payments. With the passage of the SECURE Act, a 529 savings account can be used to repay up to $10,000 of student debt.
- Nondiscrimination Testing Relief for Frozen Defined Benefit Plans: Frozen defined benefit plans can become discriminatory if the erosion of benefits of non-highly compensated employees outpaces the erosion rate of highly compensated employees. The SECURE Act includes testing relief that will make it easier for closed pension plans to satisfy certain nondiscrimination testing requirements.
There are still several unanswered questions regarding the SECURE Act’s changes to retirement plan rules. The law is a large piece of legislation that will require regulators time to digest the law and issue further guidance to assist plan sponsors in complying with the numerous plan changes. Additionally, the legislation provides for an elongated remedial period, meaning plan documents can be updated up to January 1, 2022, but the plans must comply with the provisions of the SECURE Act by the effective dates specified in the legislation (mostly January 1, 2020).
Whether the law becomes a historic piece of retirement legislation or not, won’t be decided for many years after the law’s full impact is felt. One thing is certainly clear from the passage of this legislation, Congress understands that the current retirement plan rules aren’t allowing nearly enough to allow Americans to save enough for a secure retirement.