ARTICLE | March 20, 2023 | Authored by RSM US LLP
The SECURE 2.0 Act of 2022 (SECURE 2.0 or the Act), enacted on Dec. 29, 2022, may be the most comprehensive legislation concerning retirement plans in decades. The Act has numerous provisions affecting retirement savings through employer-provided retirement plans and individual retirement accounts (IRAs). The focus of the Act is to provide incentives for employees to save more for retirement, for example by increasing contribution limits. The Act also provides incentives for more employers to offer retirement plans by reducing both start-up costs and administrative burdens.
Many SECURE 2.0 provisions apply specifically to small businesses with 100 or fewer employees (small employers). This article discusses the impacts of SECURE 2.0 on small employer retirement plans.
While small employers are free to adopt the same types of retirement plans as larger employers, such as 401(k) and defined benefit pension plans, three types of retirement plans are geared toward small employers, including simplified employee pension plans (SEPs), Savings Incentive Match Plan for Employees (SIMPLE) IRAs, and, less commonly, SIMPLE 401(k) plans, can be adopted by small employers, including sole proprietorships, partnerships, S-corporations, and C-corporations. In general, these three types of plans are designed to make it easier and less expensive to set up and administer.
SEPs have their own unique characteristics. SIMPLE- IRAs and SIMPLE 401(k) plans are similar to each other in many respects but also have their own unique characteristics. These plans are described below.
All eligible employees of the employer and its related businesses must be covered by the SEP and the employer must make contributions on behalf of each employee in the same percentage of compensation or the same uniform dollar amount as made on the behalf of an owner, although greater contributions may be possible for higher earners based on social security integration. All employees must be covered by the SEP if they are at least age 21, have worked in at least 3 of the last 5 years, earn at least $750 (2023, as indexed), and are not union employees covered by a collective bargaining agreement or nonresident aliens. Employee contributions are not allowed under a SEP.
Annual SEP contributions are limited to 25% of the employer’s aggregate employee compensation or, for businesses that have no employees, 25% of the owner’s compensation. With respect to each SEP participant, the maximum annual compensation that may be considered is $330,000 (2023, as indexed), and annual SEP contributions are limited to $66,000 (2023, as indexed). An employer does not have to contribute to a SEP every year.
SEPs are easier to administer than some other retirement plans because they are not subject to the same types of nondiscrimination testing or annual reporting requirements applicable to qualified plans. SEPs may be set up simply by completing IRS Form 5305-SEP; or by adopting an IRS-approved prototype or individually designed plan document (e.g., provided by the financial institution where the SEP IRAs are set up).
Starting in 2023, an employer may amend a SEP to allow employees to elect to have their employer-funded contribution treated as a Roth contribution. Previously, Roth contributions were not allowed in a SEP. As noted, SEPs are funded by employers not by employees. The mechanics of this election are uncertain, and guidance will be necessary from the IRS, and SEP-IRA custodians will need time to prepare new plan documents and adapt their administrative systems to accommodate this new option.
Starting in 2023, in SIMPLE 401(k) plans, eligible employees are allowed to make both pre-tax and/or Roth elective contributions to the plan by payroll deduction, up to an annual limit of $15,500 (2023, as indexed), as well as catch-up contributions starting at age 50 of $3,500 (2023, as indexed). Starting in 2023, SECURE 2.0 allows employer after-tax Roth contributions in SIMPLE-IRAs.
Under current rules, with respect to both SIMPLE 401(k) plans and SIMPLE-IRAs, employers are required to make a fully vested employer contribution either as a 3% matching contribution or a 2% nonelective contribution. Starting in 2024, however, SECURE 2.0 increases the maximum contribution limits for both SIMPLE 401(k) and SIMPLE-IRAs. The new rule allows an employer with 25 or fewer employees to make nonelective employer contributions over and above the required 2% amount, capped at the lesser of 10% of the employee’s compensation or $5,000 (2024, as indexed). Further, under SECURE 2.0, the maximum amount an employee can elect to contribute to the plan is 110% of the annual limit established by the IRS ($15,500, 2023). Employers with 26 or more employees can take advantage of this increase in the elective contribution limit only if they increase the required 3% matching contribution to 4% or increase the required 2% nonelective contribution to 3%.
SECURE 2.0 provides that, starting in 2024, a small employer sponsoring a SIMPLE 401(k) or SIMPLE-IRA is permitted to terminate the SIMPLE and replace it with a safe harbor 401(k) or 403(b) plan in the current year. This may occur, for example, because SECURE 2.0’s increased limits would allow a SIMPLE plan sponsor to make nonelective employer contributions of 3% – the same nonelective contribution required under a safe-harbor 401(k) plan. In that instance, an employer sponsoring a SIMPLE 401(k) plan may wish to convert to take advantage of the safe-harbor 401(k) plan’s higher limits for elective contributions ($22,500 vs. $15,500 for 2023) and catch-up contributions ($7,500 vs. $3,500). Additionally, a safe harbor 401(k) plan may be more flexible than a SIMPLE with respect to discretionary provisions. For example, a profit-sharing contribution may be built into a safe-harbor 401(k) plan – which may be desirable as the company grows.
Tax credits for small employer plans. SECURE 2.0 provides the following tax credits for small employers:
Effective in 2024, the Act created a new type of “starter plan” available to employers of any size but seems more suited for small employers, who have not sponsored a retirement plan in the last three years. The starter plan allows only employee elective contributions and catch-up contributions. The annual contribution limit is capped at $6,000 (effective 2024, as indexed), with a maximum of $1,000 (effective 2024, as indexed for IRAs) catch-up contribution. A starter deferral-only plan must require automatic contributions starting at 3% of compensation, up to a maximum of 15%, and is not subject to nondiscrimination testing.
The Act extends the retroactive elective contribution deadline for sole proprietors for the first year of a new plan from the end of the first year of the plan, to the sole proprietor’s tax return due date (determined without regard to any extensions) for the year the plan is adopted. For example, under the SECURE 2.0 provision, a sole proprietor with no employees could, at any time before his or her 2023 tax return due date (determined without regard to any extensions), decide to retroactively set up a 401(k) plan with a Jan. 1, 2023, effective date and contribute elective contributions up to the 2023 maximum annual limit. Prior to SECURE 2.0, the retroactive plan had to be adopted by the end of the year for which the contributions were made.
Starting in 2025, plan sponsors will have to include an eligible automatic contribution arrangement in most new 401(k) or 403(b) plans set up after Dec. 31, 2024. The automatic contribution rate during a participant’s first year of participation must not be less than 3% or greater than 10% unless the participant opts out, with automatic 1% annual deferral increases up to at least 10% but not more than 15% (10% for 401(k) safe harbor plans). After deferral, the plan must provide that participants have the right to withdraw automatic contributions from the plan within 90 days of the first contribution.
Automatic contribution arrangements, however, will not be mandatory for SIMPLE 401(k) or SIMPLE-IRA plans; plans of employers with 10 or fewer employees; plans of employers in existence for less than three years; and governmental and church plans. Automatic enrollment remains voluntary for 401(k) and 403(b) plans already in existence as of Dec. 29, 2022.
Under current law, temporary, seasonal, and part-time employees credited with less than 1,000 hours of service may be excluded from qualified plan participation. Starting in 2024, however, a 401(k) plan is required to enroll such employees if credited with more than 500 hours of service in three consecutive 12-month periods, solely for making elective deferrals. Starting in 2025, SECURE 2.0 extends the provision to 403(b) plan and reduces the three consecutive 12-month periods to two. This provision applies to SIMPLE 401(k) plans but not SIMPLE-IRAs.
The mandatory enrollment of these long-term part-time employees has serious implications for industries such as retail, food and beverage, healthcare and private clubs, and other industries that typically employ large numbers of seasonal, temporary, and part-time employees. Employers will be required to determine whether any of these employees is credited with 500 hours of service under a 401(k) plan in 2021, 2022, and 2023, and then further determine whether the employee had 500 hours in any three, or after 2025, two consecutive 12-month periods for both 401(k) and 403(b) plans. For 403(b) plan sponsors, years prior to 2023 can be disregarded. If an employer decides to provide a matching contribution to such long-term part-time employees, each year in which the employee is credited with at least 500 hours of service starting in 2021 (2023 for 403(b) plans) must be counted for vesting service. Long-term part-time employees may be excluded for purposes of nondiscrimination and top-heavy testing.
Starting in 2024, employers may make a matching contribution to a SIMPLE-IRA plan (as well as 401(k), 403(b), and 457(b) plans), based on the amount of a qualified student loan repayment made by a participant to a lender during the applicable period. The loan repayment amount is treated as if the participant deferred the amount under the plan, even though no deferral amount is actually withheld from the participant’s eligible compensation or contributed to the plan by the participant. Changes made by SECURE 2.0 reference Internal Revenue Code section 221(d)(1), which defines a “qualified education loan” as any indebtedness by the individual which is used to pay for higher education expenses and incurred on behalf of the individual, the individual’s spouse or any dependent. One question is whether the provision will extend to participants responsible for paying another person’s student loans, such as a son or daughter. Hopefully, clarification of this provision will be included with regulations to be issued by Treasury.
A plan may accept an employee’s self-certification with respect to the payment, although some employers may want more documentation. This provision is optional, and, in making the decision to adopt it, an employer should consider the needs of its particular workforce.
Effective Dec. 29, 2022, SECURE 2.0 provides that qualified plans may allow employees to choose to treat fully vested employer matching and other employer contributions as after-tax Roth contributions. This provision does not apply to SIMPLE-IRAs. Employees making the election are subject to income tax on the employer contributions in the election year. The IRS is expected to issue guidance on withholding on the employer contributions subject to the election, and how the provision applies to employer contributions that vest ratably. The provision is optional.
Employers are allowed, starting after Dec. 29, 2022, to encourage employees to save by providing a de minimis financial incentive to employees that is contingent on an election to make 401(k) or 403(b) plan deferrals, e.g., giving away a gift card or promotional item if they enroll. These incentives are allowed in SIMPLE 401(k) plans.
Starting in 2024, the maximum small account balance mandatory cash-out limit is increased to $7,000 (was $5,000) and applies to all distributions made after Dec. 31, 2023, from defined contribution plans, including SIMPLE 401(k) plans. This provision is not relevant for SIMPLE-IRAs.
It should be noted, however, that under current law, qualified plans are not required to provide for Roth accounts. Thus, under the SECURE 2.0 provision, employees with wages over $145,000 who participate in a plan that does not provide for Roth accounts would not be permitted to make any catch-up contributions and would not be able to take advantage of the increased catch-up contribution limits for participants ages 60 through 63.
In lieu of the disaster-by-disaster approach in current law, Congress has added permanent rules for plan loan and distributions related to federally declared disaster areas. Key features of the new provisions are:
These rules are effective for disasters occurring on or after Jan. 26, 2021.
Starting in 2024, special provisions have been added to benefit victims of domestic abuse, including the following:
Effective Jan. 1, 2024, defined contribution plans including IRAs may allow penalty-free withdrawals of up to $1,000 per year for unforeseeable or immediate financial needs relating to personal or family emergency expenses. Similar to other provisions in the Act, the taxpayer may repay the withdrawal within three years. However, only one withdrawal per three-year repayment period is allowed if the first withdrawal in the period has not either been repaid or the recipient has not contributed as a current contribution to the plan at least the amount of the withdrawal.
The Act allows plans to permit participants to open “pension-linked emergency savings accounts” in qualified plans which are separately accounted for. The pension-linked emergency savings account contributions are capped annually at $2,500 and are included in the maximum participant deferral limits applicable to the plan.
SECURE 2.0 has a number of provisions encouraging small employers to set up retirement plans by reducing start-up costs, increasing maximum annual contribution limits, and decreasing administrative burdens. Employers with less than 100 employees should review their retirement plans and analyze whether SECURE 2.0 provides opportunities for changing their plans or improving existing plans. In addition, employers who have considered adopting a retirement plan in the past but have not due to costs, administrative burdens, or for other reasons may wish to reconsider in light of SECURE 2.0. Small employers should identify and analyze new compliance issues under SECURE 2.0.
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This article was written by Joni Andrioff, Christy Fillingame, Catherine Davis, Chloe Webb and originally appeared on Mar 20, 2023.
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