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ARTICLE | March 20, 2023
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.
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.
- SEPs. A SEP may be adopted by employers of any size but is most typically adopted by small employers. Employer contributions to a SEP are made directly to an individual IRA set up by, or on behalf of, an individual employee.
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.
- Characteristics of both SIMPLE 401(k) plans and SIMPLE-IRAs. Only small employers may adopt a SIMPLE 401(k) plan or SIMPLE-IRA. A small employer who sponsors either SIMPLE plan may not sponsor any other type of retirement plan. SIMPLE 401(k) plans and SIMPLE-IRAs are not subject to nondiscrimination testing for elective contributions, provided all requirements are satisfied.
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%.
- Unique characteristics of SIMPLE 401(k) plans and SIMPLE-IRAs.
- SIMPLE 401(k) Plans. A SIMPLE 401(k) plan must cover all employees who are at least age 21 and are credited with at least 1,000 hours in the prior year. Employees covered under a collective bargaining agreement and nonresident aliens may be excluded. A SIMPLE 401(k) plan is subject to many of the same rules that apply to traditional 401(k) plans, including, for example, that plan assets must be held in a trust. Plan loans, hardship withdrawals, and other in-service withdrawals are allowed in a SIMPLE 401(k). Unlike a traditional 401(k) plan, a SIMPLE 401(k) plan is not subject to nondiscrimination testing for elective deferrals and top-heavy testing, provided certain requirements are satisfied. A small employer may adopt a SIMPLE 401(k) plan by using an IRS-preapproved 401(k) plan document and electing it to be a SIMPLE-401(k) in the adoption agreement.
- SIMPLE-IRA. Employer contributions and employee elective contributions are made to an individual IRA set up by or on behalf of an individual employee, rather than to a trust as is needed for SIMPLE 401(k) plans. Unlike a SIMPLE 401(k), no minimum age requirement applies to a SIMPLE-IRA, and it must cover all employees who earned at least $5,000 in any two prior calendar years (or who expect to earn at least $5,000 in the current year). A SIMPLE-IRA cannot offer loans, and withdrawals from a SIMPLE-IRA before age 59 1/2 will likely incur a 10% or 25% early distribution penalty, depending on the circumstances. An employer may set up a SIMPLE-IRA by adopting Form 5304 or Form 5305, or by adopting an IRS-approved prototype plan. Certain plan notification requirements apply, however, there are no annual filing requirements with a SIMPLE-IRA.
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.
SECURE 2.0 provisions applicable to small employer plans
Tax credits for small employer plans. SECURE 2.0 provides the following tax credits for small employers:
- Increased tax credit for new pension plan start-up costs. Starting in 2023, the tax credit for start-up costs of setting up a new defined contribution plan is increased for small employers. For employers with 50 or fewer employees, the tax credit increases from 50% up to 100% of the qualified costs incurred in the first three years of starting up a new plan. The credit is still limited to $5,000 per year. Employers with 51 to 100 employees are still eligible for the credit of 50% of qualified start-up costs for the first three years, with a maximum credit of $5,000 annually.
- Credit for employer contributions. Beginning in 2023, small employers can claim a credit for the employer contribution for the first five tax years beginning when the plan is set up. A per employee cap of $1,000 applies. Subject to the per employee limit, 100% of the employer contribution can be claimed in the first and second tax years; 75% in the third year; 50% in the fourth year; and 25% in the fifth year. For employers with 51 to 100 employees, the credit is reduced by 2 percentage points for each employee over 50. No credit is allowed for employer contributions on behalf of employees with wages that exceed $100,000 (2023, as indexed), or if the employer has more than 100 employees.
- Tax Credit for Military Spouse Retirement Plan Eligibility. The Act provides a tax credit of $200 for each non-highly compensated military spouse who participates in a small employer’s defined contribution plan subject to certain conditions, plus an added credit for employer contributions of up to $300 for the military spouse’s first three years of plan participation, as part of the general business credit.
“Starter” deferral only plans
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.
Extended deadline for retroactive elective contributions by a sole proprietor
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.
SECURE 2.0 provisions affecting both large and small employers
Automatic enrollment is mandatory for new 401(k) and 403(b) plans, except SIMPLEs
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.
Expansion of coverage to long-term part-time employees
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.
Student loan repayments may be treated as elective deferrals for matching purposes.
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.
Election to treat fully vested employer contributions as Roth contributions
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.
Small immediate incentives for participating in a qualified plan
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.
Increase in the small account balance mandatory cash-out limit
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.
Changes in the required minimum distribution rules apply to qualified plans, including SEPs, SIMPLE 401(k)s, and SIMPLE-IRAs.
- The age for required minimum distributions from IRAs or qualified plans is increased to age 73 for persons who reach age 72 after 2022 and age 73 before 2033; further increases to age 75 for persons who reach age 74 after 2032.
- The excise tax applicable to failures to receive required minimum distributions is reduced from 50% to 25%, and, starting in 2025, may be further reduced to 10% if corrected during the applicable correction window ending on the earlier of (1) the last day of the second tax year that begins after the year the excise tax is imposed, or (2) the date of a notice or assessment of tax.
- Required minimum distributions from a designated Roth account in a qualified plan are not needed prior to the participant’s death, for distributions related to years after 2023.
Catch-up contribution changes
- Starting in 2024, participants with annual wages up to $145,000 may make catch-up contributions with respect to both pre-tax and Roth contributions. However, participants with wages over $145,000 may make catch-up contributions only as after-tax Roth contributions. “Wages” for this purpose are defined under section 3121(a) as wages from employment, so the provision does not apply to self-employed individuals, although this point may be addressed in future IRS guidance. As noted above, after-tax Roth contributions are allowed in SIMPLE 401(k) plans and, starting in 2023, are allowed in SIMPLE-IRAs under SECURE 2.0.
- In addition, starting in 2025, the annual catch-up limit for participants ages 60, 61, 62, or 63 at the close of any tax year in a qualified plan is increased from $7,500 (2023, as indexed) at age 50 to $10,000 (or, if greater, 150% of the 2024 annual limit). For SIMPLE plans only, the annual catch-up limit increases from $3,500 (2023, as indexed) at age 50 to $5,000 (or, if greater, 150% of the 2025 annual catch-up limit). Special indexing rules apply.
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.
Permissible emergency distributions added
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:
- Up to $22,000 may be distributed to a participant per disaster,
- The amount of income included can be spread over three years,
- Amounts distributed may be repaid within three years,
- The maximum dollar amount of a disaster-related loan is the lesser of 50% of the account balance or $100,000 (increased from $50,000), and
- The 10% early withdrawal penalty on amounts included in income is waived.
These rules are effective for disasters occurring on or after Jan. 26, 2021.
Domestic abuse provisions
Starting in 2024, special provisions have been added to benefit victims of domestic abuse, including the following:
- A domestic violence victim may take a penalty-free early withdrawal of up to the lesser of $10,000 (indexed) or 50% of the value of the employee’s vested account balance in the plan.
- Amounts withdrawn may be re-contributed to the plan within three years.
- This will be a permitted in-service distribution event for 401(k), 403(b), and governmental 457(b) plans.
Self-certified emergency personal expenses
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.
Emergency savings accounts
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.
Takeaways and reminders
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.
This article was written by Joni Andrioff, Christy Fillingame, Catherine Davis, Chloe Webb and originally appeared on Mar 20, 2023.
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