SECURE Act 2.0: Summary of Key Tax and Retirement Provisions
On December 29, 2022, President Biden signed the Consolidated Appropriations Act, 2023, which is wrapped into the larger bill, Securing a Strong Retirement Act, commonly called SECURE 2.0. This package of laws is a follows the Setting Every Community Up for Retirement Enhancement (SECURE) Act signed into law at the end of 2019. SECURE 2.0 covers numerous changes to retirement provisions designed to increase retirement savings, facilitate access to retirement savings, encourage employees to save for retirement, and lower employers’ cost of offering and funding retirement savings plans. The majority of the SECURE 2.0 provisions will become effective in 2024.
Provisions Impacting All Employers
For plan years beginning after December 31, 2024, an employer with more than 10 employees who has been in existence for at least three years and who is offering a new 401(k) or 403(b) plan, must provide automatic enrollment for new employees and automatic escalation of the amount of an employee’s deferral. Under these rules, new employees will start with salary reduction of at least 3% of compensation. The rate of salary reduction increases annually by 1% of compensation until reaching at least 10%, but no more than 15%. An employee may elect out of auto enrollment and/or auto escalations.
Note: As a result of the additional administrative costs of operating a plan with these mandatory participation requirements, new businesses and existing business expecting to grow their workforce should consider adopting a retirement savings plan before the mandatory rules apply.
Designated Roth accounts in employer plans are encouraged under the new law. Roth accounts within 401(k) plans, 403(b) plans and 457 plans are no longer subject to required minimum distribution (RMD) rules. This provision puts Roth accounts on par with Roth IRAs. Prior to SECURE 2.0, employees had to transfer their Roth accounts from the employer plan to a Roth IRA to escape RMDs. Now employees can continue to compound earnings tax free after retirement within their employer’s plan.
Part-Time Employee Eligibility.
Part-time employees were encouraged to participate in employer plans under provisions in the first SECURE Act. In 2019 the tax law changed to require plans to allow long-term, part-time employees to be eligible for an employer’s 401(k) plan. SECURE (2019) permitted dual eligibility for plans: one year of service of 1,000 hours or three consecutive years of service of 500 hours. Under SECURE 2.0, part-time employees are eligible to participate in an employer’s 401(k) plan or 403(b) plan with two consecutive years of service of 500 hours. For transition purposes, pre-2021 service of part-time employees is disregarded for vesting and eligibility under this new rule.
Incentives to Participate.
Prior to SECURE 2.0, an employer could not incentivize an employee to contribute to a retirement savings plan. For plan years beginning after December 29, 2022, an employer is allowed to provide de minimis financial incentives to encourage plan participation.
Note: “de minimis financial incentive” is not a defined term. Further guidance is needed so employers can be sure they do not risk disqualification of their cash or deferred arrangement for providing these incentives to employees, unless the benefit is truly de minimis.
Overfunded Plan Option.
Many employers have overfunded defined benefit plans and find it beneficial to transfer excess assets to an account to pay retiree health benefits. Those provisions, which would have expired after 2025, are liberalized and are extended until 2032.
The rules applicable to retirement savings are complicated, resulting in numerous errors. For this reason, the Internal Revenue Service (IRS) has an Employee Plans Compliance Resolution System (EPCRS) that allows for self-correction of many errors and rules, such as entering into a closing agreement with the IRS.
The new law facilitates corrections in several ways. If a plan inadvertently pays excess amounts to retirees, the plan no longer requires repayment and the excess amounts can be rolled over without tax penalty. In addition, the law requires the expansion of errors that can be self-corrected, by mandating these provisions to be used at any time for any amounts, including errors regarding loans. The law directs the IRS to address inadvertent failures regarding required minimum distributions and rollovers by beneficiaries who are not entitled to rollover such amounts.
Plan amendments can also be adopted retroactively to increase plan benefits and avoid a violation of the rules. Because the regulatory provisions that allow for corrections for automatic enrollment and automatic escalation are scheduled to expire at the end of 2023, the law provides a grace period for making corrections of nine and a half months after the end of the plan year in which mistakes were made for errors occurring after 2023.
Encouraging Small Employers To Establish Retirement Savings Plans
For employers with no retirement plan, SECURE 2.0 provides for starter 401(k) or 403(b) plans. These starter plans limit salary deferrals to a maximum of $6,000 plus catch-up contributions for those over age 50. Automatic enrollment of employees is required, but an employee may elect out. These starter plans simplify administration by deeming that the discrimination tests are satisfied, although notice of the plan to employees is required.
For employers with 50 or fewer qualifying employees, SECURE 2.0 provides an increased tax credit for starting a plan. For plans started in 2023, the credit is increased to 100% of administrative costs and ranges from $500 to $5,000. In addition, there is an additional 100% credit of up to $1,000 per employee for employer contributions made for employees earning less than $100,000 during the first year of the plan. This credit decreases by 25% each of the following 3 years.
Employers with 51-100 qualifying employees can qualify for a similar, but lesser, credit for employer contributions. There are also additional credits for contributions for military spouses who are participating in certain employer plans.
Note: Congress is encouraging employers to fund retirement savings for employees to “kick start” retirement savings, anticipating that tax-deferred compounding of earnings will encourage both employers and employees to continue making contributions. Employers with no more than 50 employees should consider this 100% credit. Those with up to 100 employees will want to calculate the after-tax cost of contributions for employees, accounting for the credit that applies for an employer of their size. Employers claiming these tax credits will reduce their tax deductions for contributions to the plan by a like amount.
Easing Top-Heavy Plan Rules.
Many small employers do not adopt plans due to required top-heavy contributions. To increase participation in these plans, the top-heavy rules are modified for plan years beginning after 2023 to allow excludable and non-excludable employees to be tested separately, as is permitted for the 401(k) discrimination tests. This can encourage employers to offer plans to younger workers.
Solo 401(k) Plan.
SECURE 2.0 provides parity for solo 401(k) plans with IRAs. A sole proprietor who is the only employee of the business can make a deferral election for compensation contributions into their 401(k) plan up until the due date (without extensions) for the tax year’s income tax return, but only for the first year of a plan. This extended time can encourage adoption of a plan and provides more information about the earnings of the business while the sole proprietor’s tax return (including the business’s income) is being prepared. This applies for plan years beginning after December 29, 2022.
Provisions for Plan Participants
New RMD Start Date.
SECURE 2.0 pushes back the beginning date for required minimum distributions from qualified plans. Individuals turning age 72 during 2023 or later will start their RMD at age 73. For those reaching age 74 after December 31, 2032, their start date is age 75. For those able to defer their RMD to these later birthdays, retirement savings may continue to compound earnings tax deferred or tax exempt in the case of inherited Roth IRAs.
Individuals over age 50 can contribute a salary reduction catch-up contribution to an employer plan. This contribution is currently limited to $6,500 annually. For tax years beginning after 2024, employees who are 60-63 years old can take advantage of a higher catch-up contribution of $10,000. SECURE 2.0 provisions also index the IRA catch-up contribution for individuals over age 50. The current catch-up amount is $1,000, but this amount will increase for cost-of-living adjustments in tax years beginning after 2023.
SECURE 2.0 requires that catch-up contributions are designated as Roth contributions for any plan participant whose wages exceed $145,000, effective for tax years after 2023. In addition, employers can make matching and non-elective contributions to designated Roth accounts.
Annuity Investment Option.
Annuity Contracts will be more readily available within employer plans. Plan participants in account balance plans may want to use a portion of retirement plan savings to provide lifetime income. An annuity provides a lifetime income stream, as is offered by law in a defined benefit pension plan. Prior to SECURE 2.0, employer plans were generally constrained in allowing participants to purchase annuities in their accounts due to the required minimum distribution rules. SECURE 2.0 facilitates an employer’s ability to include annuity options in a plan. The new law directs the IRS to modify its regulations within 18 months to allow for more relaxed rules around the payment of premiums for an annuity, and how the annuity’s annual payment is considered in the determination of the participant’s RMD.
Limiting IRA Penalties.
The law makes clear, with no inference language for prior years, that an IRA account which loses exempt status due to a prohibited transaction does not result in a loss of exempt status for all IRAs owned by that individual. This provision should encourage those with alternative investments in IRA accounts (which could result in prohibited transactions) to use separate accounts for each investment.
RMD Penalty Relief.
If required minimum distributions are not taken, the excise tax penalty is reduced to 25% for taxable years beginning in 2023. The penalty is further reduced to 10% if correction is made within two years after the end of the taxable year in which the distribution was missed.
College Loans and Savings
Student Loan Repayment.
A few years ago, the IRS approved a plan that allowed employer contributions to be made to a 401(k) plan for employees who were repaying their student loans. Beginning in 2024 with SECURE 2.0, an employee’s student loan debt repayment can be treated as the employee’s salary deferral to a 401(k) or 403(b) plan. This is an option that an employer can add to their retirement savings plan. The advantage of this provision is to increase retirement savings for employees by allowing employer matching contributions to be made for compensation amounts employees use to pay down debt, rather than defer into the employer’s retirement savings plan.
Convert College Savings to Roth IRA.
Many individuals contribute to an IRC Section 529 plan to save for an individual’s education costs. Sometimes, these accounts hold funds that are no longer needed for education. SECURE 2.0 creates a new option for continuing to grow these funds in a tax-exempt vehicle. In 2024, owners of certain 529 plan accounts may transfer these savings into a Roth IRA. This option applies to a 529 plan account that has been in effect for at least 15 years, and the amount transferred does not exceed the total of contributions made to the 529 plan during the most recent five years. Finally, the amount transferred during a year is limited to the annual amount allowed as a Roth IRA contribution, and all transfers are limited to a maximum of $35,000.
Note: Those with Section 529 plans will want to monitor the timing of contributions and the need for education expenses to be paid from the plan to maximize the opportunity of converting amounts to Roth accounts.
Emergency Savings and Distributions
The new law permits employers to add provisions to their plans to help non-highly compensated employees save for emergencies. Employee contributions to these emergency savings accounts are not part of the employee’s regular retirement savings. These emergency savings funds are separately accounted and amounts are withdrawn at the discretion of the plan participant. The employee’s emergency savings account balance is generally limited to no more than $2,500.
SECURE 2.0 also allows plan participants to withdraw up to $1,000 annually for meeting unforeseeable or immediate family needs relating to personal or family emergency expenses. The distributions are not subject to the 10% penalty for early withdrawal for those that have not reached age 59 ½. Only one distribution can be made per year. An employee can repay the amount to the plan within three years.
Employer plans can also add similar withdrawal provisions that are exempt from the 10% penalty for plan participants who are terminally ill and for those who are victims of domestic abuse. These provisions in SECURE 2.0 have various effective dates.
Effective for disasters after December 27, 2020, SECURE 2.0 permanently exempts plan distributions from the 10% penalty for early withdrawal when meeting the following conditions:
- The individual withdraws no more than $22,000
- The individual’s principal place of residence is in a federally declared disaster area
- The individual sustains an economic loss by reason of the disaster
A qualifying disaster-related distribution can be included in income over three years or the individual can repay the distribution amount to the plan within three years. Using the above criteria, an individual can borrow from the qualified plan up to a maximum of $100,000 or 100% of the vested account balance. Loan repayment periods for these individuals for existing loans are extended for one year.
The discussion above highlights some, but not all, of the new provisions in SECURE 2.0 that will take effect in 2023 and 2024. Other provisions in the law will apply in later years. For further guidance on this new law and to address your specific questions for employer plans, please contact Deb Walker, David Flinchum, or your Cherry Bekaert tax advisor.