Many studies have shown that Americans are not saving enough for retirement. A surprising number of employees still do not even have access to a 401(k) savings plan. Several provisions of the recently enacted SECURE Act address this retirement savings gap by encouraging employers who currently do not sponsor 401(k) plans to adopt them. The SECURE Act also creates new incentives for 401(k) plan sponsors to help increase participants’ retirement savings and to provide them with a steady stream of income when they leave the workforce. In the longer term, beginning after 2023, the SECURE Act will additionally require 401(k) plans to allow long service part-time employees to make their own contributions (which need not be matched).
Here are some of the new opportunities for sponsors and potential sponsors to consider.
Tax Credits for New Plans and Auto-Enrollment Plans
The tax credit for small employers who start new retirement plans increases from $500 per year to as much as $5,000 per year for three years. There is also a new $500 per year tax credit for new plans that include automatic enrollment.
Additional Time to Adopt New Plans and Safe Harbor Provisions
An employer may now decide to adopt a plan after the end of the plan year and up to its tax return deadline. The prior deadline was the last day of the initial plan year. However, a plan adopted after the end of the plan year must be employer-funded and cannot permit retroactive employee contributions.
Safe harbor 401(k) plans are popular ways to avoid having to refund excess contributions when plans fail to pass nondiscrimination testing. They may be designed to either match employee contributions or to provide a nonelective contribution to every employee who has satisfied the plan’s eligibility requirements. Previously, employers could notify employees in advance that they might adopt a nonelective safe harbor provision in the next plan year. If this “maybe notice” was given, employers could adopt a nonelective safe harbor plan up to 30 days before the end of the plan year.
An employer may now decide to adopt nonelective safe harbor 401(k) provisions at any time up to the end of the subsequent plan year without giving the advance “maybe notice” to employees. This enables the plan sponsor to consider the financial results for the complete year before making a decision. Converting a plan to a nonelective safe harbor plan may also be a useful option for plans that are not passing nondiscrimination testing for the plan year. However, if the nonelective provisions are adopted after the old deadline, a minimum nonelective contribution of 4% of compensation must be given to participants instead of the 3% contribution usually required.
New Higher Limits for Auto-Enrollment
Numerous studies have shown that automatic enrollment of employees increases retirement savings. If the employer has adopted a type of safe harbor plan with automatic enrollment contributions ( called a QACA), the maximum permissible percentage of pay that may be subject to automatic enrollment has been increased from 10% to 15%.
Pooled Employer Plans Limit Fiduciary Responsibility
Fear of fiduciary responsibility and fear of being sued for a fiduciary breach deter smaller employers from adopting plans. The SECURE Act created a new type of plan called a pooled employer plan, or PEP, that permits unrelated employers to participate in a plan with professional management and consolidated reporting. PEPs are expected to benefit from economies of scale that should result in lower fees.
Banks, insurance companies, recordkeepers and investment firms are expected to be interested in offering PEPs. The fiduciary responsibility of employers participating in PEPs is limited to prudently selecting the providers and, if the arrangement does not provide for investment management by a professional fiduciary, for plan investments. The day-to-day administration will be handled by a responsible professional.
PEPs will not be available until 2021, but they are expected to expand the 401(k) marketplace.
New Safe Harbor for Selecting Annuity Providers
Although 401(k) plans are the primary source of retirement income for most employees, many plans still provide that distributions may be made only in lump sums. The employees are responsible for investing the lump sum to provide retirement income, and many do not do so. Annuity payment options solve this problem by converting the account balance into a lifetime income stream. However, employers have been reluctant to include them due to fear of being sued if the insurer encounters financial difficulties and fails to pay future benefits.
The SECURE Act creates a new fiduciary safe harbor protecting fiduciaries from such lawsuits provided that they engage in an objective, thorough and analytical search for annuity providers. Instead of having to investigate the financial condition of insurers themselves, they will now be able to complete a checklist of diligence items that rely on state insurance regulator determinations of factors such as whether the insurance company has adequate reserves. However, fiduciaries must still determine that the fees are reasonable.
Portability of Annuity Options
If a plan with annuities subsequently eliminates them, participants will now be able to roll their contracts over or to receive a distribution of an annuity contract.
New Required Notice of Annuity Value
Once the Department of Labor issues guidance, the SECURE Act will also require defined contribution plan sponsors to provide participants with an annual notice of the monthly income their account balances will provide. The hope is that the annuity calculations will serve as a wakeup call to participants who are not contributing enough to their plans.
Employers interested in implementing these options may wish to wait for formal guidance interpreting the SECURE Act provisions before moving forward. It is also advisable to consult professional advisers about the detailed requirements to ensure compliance. But it is not too soon for employers to begin considering these new options to increase retirement savings.
Carol I. Buckmann, JD is the co-founding partner of Cohen & Buckmann, P.C. (www.cohenbuckmann.com). She is one of the top-rated employee benefits and ERISA attorneys in the U.S., and deals with some of the foremost issues in ERISA, including pension plan compliance, fiduciary responsibilities and investment fund formation.
The views expressed in this article are those of the author and do not necessarily represent the views of PenChecks Trust®, its subsidiaries or affiliates.
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