SECURE 2.0 – Key Changes for Retirement Plans

With just days to go before the new year, President Biden signed the Consolidated Appropriations Act, 2023, into law on December 29, 2022, which includes the SECURE 2.0 Act of 2022 (“SECURE 2.0”). SECURE 2.0 expands on and, in some cases, modifies changes to the laws governing retirement plans brought about by the Setting Every Community Up for Retirement Act of 2019 (the “2019 SECURE Act”). Key provisions of SECURE 2.0 that amend the Employee Retirement Income Security Act of 1974 (“ERISA”) and the Internal Revenue Code (the “Code”) include a mandatory automatic enrollment and escalation feature for new Section 401(k) and 403(b) plans starting in 2025, updated required beginning dates for taking required minimum distributions, an expansion of the Internal Revenue Service (“IRS”) Employee Plans Compliance Resolution System (“EPCRS”), and more “Rothification” of savings opportunities for retirement plan participants.

Plan amendments under SECURE 2.0 are generally required by the last day of the first plan year beginning on or after January 1, 2025 for single-employer plans. SECURE 2.0 also directs the United States Department of Labor (“DOL”) and IRS to issue various new regulations in accordance with its provisions. This article summarizes some of the key features of SECURE 2.0 that affect retirement plans.

Coverage and Savings Through Qualified Plans

• Automatic Enrollment 
  • Beginning in 2025, Sections 401(k) and 403(b) plans must include an automatic enrollment feature for eligible employees with a default elective deferral rate between 3-10%. This is a significant change in the law, which did not previously require auto-enrollment. New plans generally must also provide for automatic escalation of contributions of 1% per year up to at least 10%, and no more than 15%. Notably, these provisions only apply to new plans (i.e., those adopted after December 29, 2022), and for Plan Years commencing on or after January 1, 2025. Plans existing prior to December 29, 2022 do not need to be amended to include these features, nor do these provisions require employers to adopt plans if they do not choose to do so.
  • SECURE 2.0 gives employees the right to opt out of the auto-enrollment and auto-escalation features.
  • If auto-enrolled employees do not select their own investments, SECURE 2.0 directs that their contributions be invested in the plan’s qualified default investment alternative (“QDIA”).
  • SECURE 2.0 also contains exceptions for certain plans and employers, such as for plans sponsored by employers that have been in existence for less than three years or have fewer than 10 employees.
  • SECURE 2.0 does not clarify whether plans that are spun-off or merged after December 29, 2022 will be considered new plans for the purpose of this auto-enrollment requirement.

• Expanded Eligibility for Part-Time Workers
  • The 2019 SECURE Act made it easier for part-time employees to participate in 401(k) plans by requiring eligibility for employees who either complete one year of service working at least 1,000 hours, or who complete three consecutive years of service working at least 500 hours in each year. SECURE 2.0 makes even more part-time employees eligible to participate in 401(k) plans by lowering the three-year measurement period to two years beginning in 2025, and by applying the part-time employee eligibility rule to 403(b) plans subject to ERISA as well.
  • SECURE 2.0 also provides that part-time employees must receive vesting credit for each year in which they have at least 500 hours of service, beginning in 2023.

• Increased Catch-Up Contributions in 2025, But Roth Requirements in 2024 
  • Under current law, a plan may permit employees who have attained at least age 50 to make additional, “catch-up” contributions to their retirement plans above otherwise-applicable limits. Catch-up contributions are limited to $7,500 for 2023 (and $3,500 for SIMPLE plans). Effective in 2025, employees who are ages 60-63 will be able to make increased catch-up contributions up to the greater of $10,000, or 150% of the regular catch-up limit in effect in 2024. (For SIMPLE plans, $10,000 is replaced by $5,000.)
  • However, effective in 2024, catch-up contributions made by any employee with wages of greater than $145,000 (indexed) must be made on a Roth basis. This is a change from current law, which provides that catch-up contributions may be made on a pre-tax or Roth basis. SECURE 2.0 also provides that regulations may give employees the ability to change their elections from pre-tax to Roth if it is determined that their wages for a calendar year exceed $145,000 after their election for such calendar year is made.

• More Roth Savings Options
  • SECURE 2.0 provides even more opportunities for retirement savers to “Rothify” their accounts by giving plans the ability to allow participants to elect to receive some or all of their matching and nonelective contributions on a Roth basis, to the extent such contribution is vested when made.

• Savers Match
  • Current law provides that lower-income individuals who save for retirement receive a tax credit. Beginning in 2027, instead of receiving a tax credit they will receive the Savers Match in the form of a matching contribution from the government to their retirement plan or individual retirement account (“IRA”) up to 50% of their contribution, based on income, but no more than $2,000.

• Student Loan Payment Matching Contributions
  • Effective after 2023, sponsors of Sections 401(k), 403(b) and certain 457(b) plans may make matching contributions under the applicable plan for student loan repayments as if those repayments were elective deferrals. These matching contributions will be treated like regular matching contributions for purposes of nondiscrimination testing.

• De Minimis Financial Incentives
  • SECURE 2.0 changes current law to provide that employers may offer de minimis financial incentives to boost participation in retirement plans effective for plan years beginning after December 29, 2022 (though it offers no guidance on what will be considered “de minimis”). These incentives cannot be purchased with plan assets.

• Potential Future Enhancement of 403(b) Plans
  • Current law provides that Section 403(b) plans can invest in publicly traded mutual funds and annuity contracts, but not in collective investment trusts (“CITs”). CITs can be attractive retirement plan investments because they often come at a lower cost than other types of investment options, and current law provides that retirement plans like 401(k) plans and defined benefit pension plans can invest in CITs. The text of SECURE 2.0 would expand permissible 403(b) plan investments to include CITs. Such an expansion, however, would require corresponding changes to applicable securities laws that were included in earlier drafts of SECURE 2.0 but not in the final legislation. 403(b) plans thus cannot invest in CITs unless and until applicable securities laws are also updated.

Emergency Savings and Distribution Provisions

• Emergency Savings Accounts
  • Defined contribution plan sponsors will be permitted to offer their non-highly compensated employees the option to make Roth contributions to an emergency savings account connected to their retirement account effective for 2024. These accounts will be subject to various additional disclosure and notice requirements contained in SECURE 2.0, and no contribution can be made that would cause the portion of the account balance attributable to participant contributions to exceed the lesser of $2,500 (indexed) or an amount determined by the plan sponsor.
  • Like employer matching contributions on student loan payments, matching contributions to an emergency savings account must be made at the same rate as any other matches made on account of elective deferrals. Note, however, that these matching contributions may not be deposited into the emergency savings account but instead into the retirement portion of their plan.
  • Participants who contribute to an emergency savings account must be able to take a distribution from their account at least once per month.

• Emergency Expense Withdrawals
  • Sponsors of certain eligible retirement plans may allow participants to make one withdrawal annually of up to $1,000 for certain emergency expenses without being subject to the 10% early distribution penalty. An employee who makes an emergency withdrawal may repay the plan within three years if they so choose. If they do not, emergency withdrawals under SECURE 2.0 will not be permitted for the three years after the initial withdrawal. The plan administrator may rely on an employee’s certification that the withdrawal is due to an emergency as defined in SECURE 2.0. This change is applicable to distributions made after December 31, 2023.

• Other Penalty-Free Early Withdrawals for Cases of Domestic Abuse, Terminal Illness, and Federal Disasters 
  • SECURE 2.0 amends Section 72(t) of the Code by providing expanded optional distribution options without imposing a 10% penalty on individuals who are generally less than 59½ years of age in need of emergency funds. For example, starting in 2024, retirement plans may allow participants who self-certify that they experienced domestic abuse within the past year to withdraw the lesser of $10,000, indexed for inflation, or 50% of their account without being subject to the 10% penalty tax on early distributions. The participant may repay the withdrawn money within three years.
  • Additionally, SECURE 2.0 provides that an individual who is terminally ill (as certified by a physician) may take an early distribution that is not subject to the 10% tax on early distributions, effective after December 29, 2022.
  • SECURE 2.0 also creates a permanent rule allowing participants to take early distributions up to $22,000 in connection with federally declared disasters occurring on or after January 26, 2021. These distributions are not subject to the 10% tax on early distributions, may be included in income over three years, and may be recontributed to the plan. Plans may also allow participants affected by a federally declared disaster to take an increased loan of up to $100,000 (or, if less, 100% of a participant’s account balance) and receive a one-year extension of time to repay the loan.

• Reliance on Employee Certification of Hardship
  • Provided that a plan administrator does not have knowledge to the contrary, SECURE 2.0 permits plans to rely on a participant’s self-certification of having experienced an event that constitutes a “hardship” under the applicable regulations for purposes of taking a hardship distribution. (Note, however, that some IRS guidance already seemed to provide for this.) SECURE 2.0 also codifies the rule that plan administrators may rely on a participant’s self-certification that the hardship withdrawal amount is not more than necessary to meet the financial need.

• Hardship Withdrawal Rules for 403(b) Plans
  • SECURE 2.0 modifies rules relating to hardship withdrawals from Section 403(b) plans to conform them to 401(k) hardship rules. For example, SECURE 2.0 expands the hardship distribution sources available under 403(b) plans to mirror 401(k) plan rules. This change is effective for plan years beginning after 2023.

Required Minimum Distributions

• Required Beginning Date
  • One of the best-known provisions of the 2019 SECURE Act was to increase the age for required minimum distributions from 70½ to 72. SECURE 2.0 increases that age once again to 73 for individuals who attain age 72 on and after January 1, 2023, and to 75 beginning on January 1, 2033, for individuals who attain age 74 after December 31, 2032.

• Reduction in Excise Tax Regarding Required Minimum Distributions
  • Failure to take timely minimum distributions results in the imposition of an excise tax on the participant. Effective for taxable years beginning after December 29, 2022, SECURE 2.0 reduces the penalty for failure to take required minimum distributions from 50% to 25% of the difference between the amount actually distributed and amount that should have been distributed, and potentially as low as 10% if the failure is corrected in a timely manner.

• Removal of Required Minimum Distribution Barriers of Life Annuities
  • SECURE 2.0 eliminates certain barriers affecting the availability of lifetime annuities in qualified plans and IRAs, effective beginning in calendar year 2023.

• Roth Amounts and Required Minimum Distributions
  • Pre-death required minimum distributions will no longer be required for Roth amounts held in an employer retirement plan for tax years beginning after December 31, 2023.

• Qualifying Longevity Annuity Contracts
  • Current law provides that plan participants and IRA holders may use the lesser of 25% of the value of their account or $145,000 to purchase a Qualified Longevity Annuity Contract (“QLAC”), which is an annuity that begins payment at or around the end of the participant’s life expectancy. Under SECURE 2.0, QLACs purchased on or after SECURE 2.0’s date of enactment are no longer subject to the 25% limitation and the permitted dollar amount is increased to $200,000, indexed for inflation. SECURE 2.0 also clarifies that QLACs can include a “free look” period of up to 90 days from the date of purchase, during which a participant may rescind purchase of the contract; this provision applies retroactively to contracts acquired on or after July 2, 2014. SECURE 2.0 requires that the IRS update the relevant regulations within 18 months of its enactment.

• Automatic Rollovers and Portability Transactions
  • Under current law, a qualified retirement plan may include a “force-out” provision requiring cash outs of any participant with a balance of $5,000 or less without participant consent. Such amounts must generally be rolled over into an IRA (amounts below $1,000 may be cashed out via check). For distributions made after December 31, 2023, the permissible forced cash-out amount will increase from $5,000 to $7,000. SECURE 2.0 further permits retirement plan service providers to provide automatic portability services. This would involve the automatic transfer of the amount rolled into the IRA into the participant’s new employer retirement plan, provided certain conditions are met.

Plan Administration, Error Correction, and Related Notices

• EPCRS Expansion
  • The IRS currently provides for a self-correction program (“SCP”) that allows plans to fix certain failures without a submission to the IRS, the Employee Plans Compliance Resolutions System (“EPCRS”). SECURE 2.0 expands the availability of self-correction for under EPCRS to “any eligible inadvertent failure,” which is a failure that occurs even though the plan has instituted practices and procedures to allow it to comply with applicable legal requirements. Self-correction is not available, however, if the IRS discovers the error before the employer has demonstrated a commitment to correct it, or if the self-correction is not completed within a “reasonable period” after the failure is identified. SECURE 2.0 also expands EPCRS to cover plan loan failures and to errors involving IRAs. The IRS is required by SECURE 2.0 to issue updated EPCRS guidance within two years of the bill’s enactment.

• Recovery of Overpayments
  • Under SECURE 2.0, retirement plan fiduciaries may decide whether to recoup overpayments mistakenly made to participants. If a plan fiduciary exercises its fiduciary discretion to recoup all or part of an overpayment, SECURE 2.0 implements a number of safeguards to protect the participant. SECURE 2.0 further protects participants who receive an overpayment by providing that rollovers of those overpayments continue to be valid and can be treated as eligible rollover distributions. This provision is effective as of December 29, 2022.

• Retirement Savings Lost and Found
  • Within two years of its enactment, SECURE 2.0 requires the DOL to create an online searchable “Retirement Savings Lost and Found” database to help participants locate the administrator of retirement plans in which they may have a balance. To accomplish this, SECURE 2.0 requires plans to report various information to the DOL, such as contact information for participants and the plan administrator. SECURE 2.0 also directs the DOL and IRS to ensure personal information maintained in the database is protected and allow individuals to opt-out of inclusion in the database.

• Disclosure Requirements for Lump Sum Windows
  • When a pension plan is amended to provide for a temporary “window” during which participants can elect to take a lump sum instead of future monthly payments, SECURE 2.0 now requires that the plan administrator must issue a special notice to participants at least 90 days before the window opens, and also notify the DOL and the Pension Benefit Guaranty Corporation (“PBGC”) of the window. The notice to participants must contain information such as available benefit options under the plan and their relative value compared to the lump sum, an explanation of how the lump sum is calculated, and potential ramifications of accepting the lump sum. SECURE 2.0 also requires the DOL to issue a model notice and implementing regulations. The provision will not take effect until such regulations are issued.

• Requirements to Provide Paper Benefit Statements
  • SECURE 2.0 amends ERISA to provide that individual account plans must furnish one statement per year in paper form, and pension plans must provide one statement every three years in paper form. Plans are not required to comply with this provision to the extent that participants opt to receive statements electronically or plans that take advantage of the DOL’s electronic disclosure rules. However, SECURE 2.0 directs the DOL to update its 2002 electronic disclosure safe harbor to provide that any new participant or beneficiary who first becomes eligible for benefits after December 31, 2025, must receive a one-time initial paper notice. The annual paper statement requirement is effective for plan years beginning January 1, 2026.

• Notice to Unenrolled Employees
  • Effective for plan years starting January 1, 2023, plans are no longer required to provide certain notices to “unenrolled employees,” i.e., those who have elected not to participate. Instead, individual account plans will be required to send an annual reminder notice of the employee’s eligibility to participate and applicable enrollment deadlines.