Major Retirement Plan Changes in the SECURE 2.0 Act of 2022

On December 29, 2022, President Biden signed into law the SECURE 2.0 Act of 2022 as part of the Consolidated Appropriations Act, 2023. SECURE 2.0 features more than 350 pages of new laws affecting retirement plans, and represents the largest legislative initiative in the retirement plan area since the Pension Protection Act of 2006.

The following is a very brief overview of the most significant provisions of SECURE 2.0 that will affect retirement plans. More details on these provisions will emerge as the U.S. Department of Labor (DOL), the Internal Revenue Service (IRS), and the Pension Benefit Guaranty Corporation (PBGC) issue regulations and interpretive guidance on the SECURE 2.0 topics.

• Changes to catch-up contributions. In 401(k), 403(b), and governmental 457(b) plans, participants who are age 50 or older have been able to make additional catch-up contributions beyond the annual deferral limit. For 2023, the catch-up contribution limit is $7,500. Under SECURE 2.0, the catch-up contribution limit will increase for participants who will attain ages 60-63 during the year to $10,000 (or, if greater, 150 percent of the catch-up contribution limit that is otherwise in effect for in 2024 for participants who are ages 50-59). The limit adjusted for cost-of-living increases after 2025. This change is effective for taxable years beginning after December 31, 2024.

  However, SECURE 2.0 also provides that, for any participant whose wages for the preceding year exceed $145,000 (as adjusted for cost-of-living increases), any age-based catch-up contributions must be made on a Roth after-tax basis. This requirement is effective for taxable years beginning after December 31, 2023.

• Required minimum distribution (RMD) changes. Amounts subject to Roth after-tax treatment will no longer be subject to the required minimum distribution (RMD) rules prior to the participant’s death. In other words, when a participant reaches his or her required beginning date, Roth amounts held in a qualified plan (or a 403(b) or 457(b) plan) do not have to be distributed as RMDs. This change is effective for tax years beginning after December 31, 2023.

  The required beginning date for RMDs is being changed (again). In general, the current required beginning date is April 1 of the year following the later of the year in which the participant reaches age 72 or the year in which the participant has a severance from employment. Under SECURE 2.0, the applicable age is changing to age 73 (for individuals who attain age 72 after December 31, 2022, and age 73 before January 1, 2033) and to age 75 (for individuals who attain age 74 after December 31, 2032). This change is effective for distributions required to be made with respect to individuals who attain age 72 after December 31, 2022. It does not affect participants who are due their first RMD on April 1, 2023, under the existing rules.

  When a plan fails to make an RMD when due, the plan has an operational failure and the individual is subject to an excise tax equal to 50 percent of the RMD amount. SECURE 2.0 reduces the individual excise tax from 50 percent to 25 percent. The individual can further reduce the excise tax to 10 percent by receiving the RMD and paying the excise tax by the last day of the second taxable year following the year in which the RMD was due. This change is effective for taxable years beginning after December 29, 2022.

• Changes affecting ESOPs. Under section 1042 of the Internal Revenue Code, a business owner can defer recognition of income upon the sale of employer securities to an employee stock ownership plan (ESOP) if he or she purchases qualified replacement property and meets certain other requirements. Historically, this non-recognition treatment has only been available if the employer securities being sold are stock in a subchapter C corporation. SECURE 2.0 extends section 1042 non-recognition treatment to the sale of S corporation employer securities, but only with respect to 10 percent of the amount realized on the sale of such employer securities. This change is not effective until after December 31, 2027.

  More generally, SECURE 2.0 directs the DOL to establish an Employee Ownership Initiative to promote employee ownership at the state and federal levels.

• Section 403(b) plan investments in collective trusts. After years of discussion, SECURE 2.0 finally permits section 403(b) plans to invest in collective investment trusts, thereby eliminating an unnecessary distinction from section 401(k) plans. This change is effective for investments made after December 29, 2022.

• Small dollar cash-out limit increased. An employer-sponsored retirement plan may “cash out” a terminated participant whose vested accrued benefit or account balance is worth $5,000 or less without the participant’s consent. Under SECURE 2.0, this cash-out threshold is increasing to $7,000. This change is effective for distributions made after December 31, 2023.

• Matching contributions for student loan repayments. Following the issuance of an IRS private letter ruling which authorized certain employer contributions to a 401(k) plan in connection with an employee’s repayment of student loans, SECURE 2.0 allows employers to add such a feature to their 401(k), 403(b), and governmental 457(b) plans. Basically, an employer may elect to treat qualified student loan repayments in the same way as employee elective deferrals for purposes of making employer matching contributions to the retirement plan. This change is effective for plan years beginning after December 31, 2023.

• Automatic enrollment changes. Any new 401(k) or 403(b) plans established after December 31, 2024, will be required to include automatic enrollment and escalation features. Participants who do not opt out must be auto enrolled and will make contributions of three to 10 percent of pay, as determined by the plan sponsor. Such contributions will automatically escalate on an annual basis by 1 percent per year up to 15 percent, as determined by the plan sponsor. Contributions are automatically invested in the plan’s qualified default investment alternative (QDIA) unless the participant elects otherwise. This requirement does not apply to government plans, church plans, new businesses that have been in existence for less than three years, or small employers that normally employ 10 or fewer employees. This change is effective for new plans only in plan years beginning after December 31, 2024.

• Employer contributions may be treated as Roth after-tax contributions. SECURE 2.0 allows an employee to elect to treat employer matching contributions, as well as fully vested employer non-elective contributions, as Roth after-tax contributions. This optional treatment is available for contributions made after December 29, 2022.

• Expanded coverage for part-time workers. Building upon a provision of the original SECURE Act, SECURE 2.0 requires 401(k) and 403(b) plans to permit part-time employees who complete at least 500 hours of service in two consecutive 12-month periods (and who are at least age 21) to participate and make elective deferrals. Vesting service for such participants also is based on completion of 500 hours of service in a year. Employers are not required to make employer contributions with respect to these part-time employees who are permitted to participate under the more generous eligibility rules. This change is effective for plan years beginning after December 31, 2024, and no periods prior to January 1, 2023, are taken into account in determining eligibility or vesting.

• Emergency personal expense distributions. A defined contribution plan may be amended to allow participants to withdraw amounts from their accounts for emergency personal expenses, generally up to $1,000. Emergency personal expenses are amounts needed to satisfy an unforeseeable or immediate financial need relating to necessary personal or family emergency expenses. The plan administrator may rely on the employee’s certification that the requested withdrawal satisfies the requirements. This change is effective for distributions made after December 31, 2023.

• Recovery of retirement plan overpayments. SECURE 2.0 amends ERISA to address the extent to which a retirement plan fiduciary may recoup an inadvertent overpayment made to a plan participant or beneficiary. The fiduciary may determine, in its discretion, not to seek recoupment of the overpayment from the participant, beneficiary, plan sponsor, employer, or other fiduciary. In the case of a defined benefit pension plan, the fiduciary would have to determine that the failure to recover the overpayment faster than required under the minimum funding rules will not materially affect the plan’s ability to pay benefits when due.

  If the fiduciary decides to seek recoupment of the overpayment, certain conditions apply. The fiduciary cannot seek interest or fees on the overpayment, efforts at recoupment cannot be accompanied by threats of litigation (unless the fiduciary has determined that there is a reasonable likelihood of success in recovering an amount greater than the cost of recovery), and the fiduciary may not use a collection agency or similar third party (unless the participant or beneficiary has ignored a court order or settlement). Recoupment of an overpayment to a participant cannot be sought from a beneficiary, and no recoupment is available if the first payment occurred more than three years before the participant is first notified of the error.

  In the case of an annuity, reductions in future payments must cease after the plan has recovered the overpayment, the amount recouped in a year cannot exceed 10 percent of the full amount of the overpayment and future benefit payments cannot be reduced below 90 percent of the periodic amount otherwise due under the plan.

  Exceptions apply where the participant or beneficiary is culpable in the overpayment, or has engaged in fraud or misrepresentation. These changes are effective as of December 29, 2022.

• Enhanced notice of lump sum windows. When a lump sum window is offered under a defined benefit pension plan, the plan administrator will be required to issue an enhanced written notice to eligible participants and beneficiaries, as well as notice to the PBGC. The participant notice must be provided 90 days before the lump sum window is opened, and the PBGC notice must be distributed 30 days before the window is opened. The participant notice must include details on the available benefit options, how the lump sum is calculated, whether the lump sum includes subsidized early retirement benefits, and the relative value of each option. SECURE 2.0 directs the DOL to issue a model notice.

  The PBGC notice must identify the total number of eligible participants and beneficiaries, the length of the lump sum window, and an explanation of how the lump sum is calculated.

  SECURE 2.0 also requires a post-window notice to the DOL and PBGC regarding the number of participants and beneficiaries who accepted the lump sum offer.

  These changes are effective once DOL regulations are finalized, and the DOL is directed to issue regulations no earlier than December 29, 2023.

• Review of pension risk transfer guidance. Given the uptick in recent years in pension risk transfer transactions, where the assets and liabilities of defined benefit pension plans are transferred to a commercial annuity provider, Congress has directed the DOL to review its existing guidance for fiduciaries engaging in such transactions. The DOL guidance, currently set forth in Interpretive Bulletin 95-1, is nearly 30 years old. The DOL is directed to report back to Congress by December 29, 2023.

• Expansion of EPCRS and Correction Procedures. For the past several decades, the IRS has maintained the Employee Plans Compliance Resolution System (EPCRS) to allow plan sponsors to fix, on a voluntary basis, certain form and operational failures in their retirement plans. EPCRS allows for both self-correction and IRS-approved correction in certain circumstances. In SECURE 2.0, Congress has made self-correction available for all eligible inadvertent failures, thereby greatly expanding the circumstances in which self-correction is available under EPCRS.

  SECURE 2.0 also allows a plan sponsor to correct certain operational failures involving automatic enrollment or escalation features, as well as the failure to afford an eligible employee the opportunity to make an affirmative election to defer compensation. Basically, if the error is corrected no later than nine and a half months following the year in which the error occurred, the employer does not have to make up any missed employee elective deferrals. However, the employer must still correct any missed employer contributions, plus earnings.

  These changes are effective after December 31, 2023, but good faith reliance is available until that date.

• Retirement Savings Lost and Found.In SECURE 2.0, Congress directs the DOL, in consultation with the IRS, to establish an online searchable database known as “Retirement Savings Lost and Found.” The database is intended to identify the plan administrator of any plan that may hold a terminated vested participant’s accrued benefit or account balance, and provide contact information to the participant. The plan administrator will need to submit certain information about terminated vested participants to the DOL. SECURE 2.0 contemplates that the DOL will have the database up and running by the end of 2024.

• Emergency savings accounts linked to defined contribution plans. SECURE 2.0 creates a new option for plan sponsors of defined contribution plans whereby a participant can establish a limited short-term emergency savings subaccount within his or her retirement plan account. The emergency savings subaccount balance would be capped at $2,500, and would consist of Roth after-tax contributions. A participant would be able to withdraw from the emergency savings subaccount once per month, and would not be subject to any withdrawal fees for the first four withdrawals during a year. A variety of limitations and other requirements, including notice requirements, apply. This change is optional, and is available for plan years beginning after December 31, 2023.

• Plan amendments. SECURE 2.0 provides that any plan amendments needed to reflect the provisions of SECURE 2.0 must be made no later than the last day of the first plan year beginning on or after January 1, 2025. For calendar year plans, the SECURE 2.0 amendments would need to be made no later than December 31, 2025. Until then, plans need to be operated in good faith compliance with the SECURE 2.0 changes.

Ballard Spahr attorneys in the Employee Benefits and Executive Compensation Group assist a variety of clients with a wide range of needs, enabling us to develop a broad practice with strength across the many areas of benefits-related legal compliance. Contact us for more information.

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