New retirement plan rules for 2020 and beyond

As 2019 was winding to a close, Congress passed, and the President signed, an omnibus spending package that includes new tax law changes. The centerpiece of the new tax legislation is the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, which represents the first significant legislation affecting retirement plans in more than a decade.

KEY POINT: Unlike many tax laws that provide for lengthy transition periods, major provisions of the SECURE Act kick in right away, starting in 2020.

While a comprehensive analysis of this important new legislation could fill volumes, here’s a rundown of major provisions affecting employers and employees.

For employers

MEPs and PEPs. Multiple Employer Plans (MEPs) allow smaller businesses to team up to provide a defined contribution plan such as a 401(k) plan to their combined group of employees. By combining employees and assets into a single plan, a MEP can produce cost savings similar to those enjoyed by large employer plans. Under current rules, however, employers participating in a MEP must have a commonality of interest—such as belonging to the same industry. The SECURE Act creates a new type of “open MEP”—called a pooled employer plan (PEP)—that can cover employers with no relationship other than participation in the plan. PEPs will be permitted for plan years beginning after 2020. The SECURE Act also cuts the risks for employers participating in MEPs by providing relief from the so-called “one bad apple” rule that could result in disqualification of the entire plan because of a violation by one participating employer.

Tax credits. Employers that sponsor a 401(k) plan or a SIMPLE IRA plan for employees can automatically enroll eligible employees in the plan unless the employees opt out. The SECURE Act creates a new tax credit for employers that establish new 401(k) or SIMPLE IRA plans that include automatic enrollment or that convert an existing plan to an automatic enrollment design. The amount of the credit is $500 per year for each of the three tax years beginning with the first year the employer adopts an automatic enrollment feature.

The new tax credit applies for tax years beginning after 2019, so employers can begin to cash in on the credit this year. For new plans, the credit applies in addition to the small employer pension plan startup credit for small employers that adopt a new qualified retirement plan. Moreover, for tax years beginning after 2019, the maximum amount of that credit is increased from $500 to as much as $5,000 per year for three years.

KEY POINT: The SECURE Act also extends the deadline for adopting a new plan for a tax year. Under prior law, a plan had to be adopted by the last day of the tax year to be treated as in effect for the year. The new law provides that a plan clan be adopted for a tax year up until the due date (including extensions) for the tax return for the year. This change applies for plans adopted for tax years after 2019. So, calendar employers have until the due date of the 2020 return to set up a new plan and cash in on tax credits and other plan benefits.

For employees

Part-timer participation. Under current rules, employer-sponsored 401(k) plans can exclude an employee from participation if he or she has not worked for the employer for at least 1,000 hours in a 12-month period. Effective for plan years beginning after 2020, the new law requires employers to allow long-term part-timers to make elective deferrals to a 401(k) plan if they have worked at least 500 hours in three consecutive 12-month periods. The law does not require the employer to make matching or other employer contributions for long-term part-timers [IRC §§401(k)(2)(D);(k)(15)].

KEY POINT: This law change technically applies for plan years beginning after 2020. However, eligible part-timers should not expect to enroll in their employers’ 401(k) plans starting next year. For purposes of counting hours under the 500-hour rule, only service performed after 2020 is required to be taken into account. So, the earliest part-time employees could be eligible is Jan. 1, 2024.

Lifetime income disclosure. Under current rules, a defined contribution plan must provide benefit statements to employees on an annual or more frequent basis showing the amount of participants’ account balance. The SECURE Act will also require a defined contribution plan to provide the participant with an estimate of his or her lifetime income stream based on the account balance. Employees won’t see this information on the account statements right away, however. The requirement will apply to benefit statements provided more than 12 months after the Department of Labor issues final regulations and other guidance.

Plan withdrawals. A distribution from a qualified plan or individual retirement account (IRA) before age 59 ½ is generally included in income and subject to a 10% early withdrawal penalty. However, the tax law carves out a number of exceptions to the penalty tax—for example, for distributions from an IRA (but not a qualified plan) for certain higher education expenses or for a first-time home purchase. The SECURE Act carves out a new exception for withdrawals for birth or adoption expenses. Effective starting in 2020, a withdrawal by an individual of up to $5,000 is penalty free if made during the one-year period beginning on the date which a child of the participant is born or legally adopted.

Required distributions. Under longstanding rules, an IRA owner has been required to begin taking required minimum distributions (RMDs) by April 1 following the calendar year in which he or she turned 70 ½. For a participant in a qualified plan (other than a 5% owner), RMDs were generally required to begin by April 1 following the later of the calendar year in which the participant turned 70 ½ or retired. RMDs for 5% owners were subject to the same rules as IRAs.

Under the SECURE Act, the trigger for beginning RMDs is moved to age 72. So, for an IRA (or a 5% owner under a qualified plan), no RMD is required until April 1 of the year following the calendar year in which the owner reaches age 72. Similarly, for a non-5% owner participant under a qualified plan, no RMD is required until April 1 of the year following the calendar year in which the participant reaches age 72 or retires.

The law change is effective for RMDs required to be made after 2019 with respect to individuals who attain age 70 ½ after that date. So, for example, an IRA owner who was born in February who turns age 70 ½ in August 2020 will not have to begin taking distributions by April 2021 as scheduled. Instead, no distributions will be required until April of 2023, the calendar year following the year in which the IRA owner turns age 72 (2022).

IRA contributions. Under longstanding rules, contributions to a traditional IRA were not allowed once the IRA owner attained age 70 ½. Starting in 2020, the SECURE Act allows an individual of any age to make contributions to a traditional IRA, as long as the individual has compensation income from wages or self-employment.