As part of the omnibus spending bill passed in a frenzy before the holiday break, Congress included the Securing a Strong Retirement Act of 2022 (“SECURE 2.0 Act”). This new law contains several changes that will have a profound impact on the rules governing retirement plans. This Insight summarizes the top five provisions affecting plan sponsors and participants.

1. Mandatory Automatic Enrollment in New 401(k)

The SECURE 2.0 Act requires new 401(k) plans to automatically enroll eligible employees as plan participants. This is a significant change. Previously, employers were not required to automatically enroll employees, although they had the option to set up their plans do so. The new law changes this default, but only for plans established after the new law takes effect and only for plan years beginning 2025 and after. It does not apply to plans already established or to certain other plans, including church or small business plans.

New plans must automatically enroll participants in a plan that is an eligible automatic contribution arrangement (EACA). Under an EACA, (1) an employer automatically enrolls employees in the plan (although employees may elect to opt out); (2) the plan treats employees as having elected to make contributions to the plan; (3) the plan document specifies a uniform percentage of wages that will be withheld from all employees after giving them notice; and (4) employees may elect to reduce or eliminate the default withholding. An EACA may allow employees to withdraw automatic contributions (including earnings) within 90 days of the first automatic contribution without being subject to the 10% penalty on early withdrawals.

The SECURE 2.0 Act also requires employers to automatically enroll employees at a contribution rate between 3% - 10% of their earnings, although the employee may opt out or elect a different percentage. These contribution rates must increase by 1% each year, up to at least 10%. With some exceptions, an employer may opt to continue increasing the contribution rate up to a maximum of 15%.

If employees do not select their own investments, the plan must invest automatically-enrolled employees’ contributions in the plan’s qualified default investment alternative (QDIA). Department of Labor regulations already in effect limit some fiduciary liability for QDIAs. Human resources (HR) and payroll departments must work closely together to implement auto-enrollments as this is an area that is heavily audited by the Internal Revenue Service (IRS). Fiduciaries must select a “prudent” QDIA for its plan lineup. This takes time and training.

A new plan that fails to implement these automatic enrollment and contribution requirements risks losing its tax-favored status.

2. Lower Eligibility Requirements to Enable Part-Time Workers to Participate in 401(k) Plans

The SECURE 2.0 Act changes the eligibility requirements under 401(k) so that it is easier for part-time employees to participate in them. An earlier enacted law, sometimes referred to as the SECURE 1.0 Act, allows plans to limit eligibility for participation of part-time employees who reach the later of: (1) age 21 or completion of one 12-month period in which the employee worked at least 1,000 hours; or (2) three consecutive years of service with 500 or more hours in each year. Most employers implemented the same eligibility for part-time and full-time employees because the IT costs were more than the cost of letting all employees participate at the same time.

Under the SECURE 2.0 Act, a plan must allow a part-time employee to participate if the employee has either satisfied the above rule #1, or if the employee has completed two consecutive 12-month periods in which the employee worked at least 500 hours in each one of the two periods and reached age 21 by the end of the second 12-month period.  This is extremely complicated for most 401(k) plan sponsors, so we anticipate most sponsors will again treat part-time eligibility the same as full-time eligibility to avoid costly mistakes.

Among other exclusions, the new rule does not apply to employees who participate in collectively bargained plans or nonresident aliens. These changes take effect for plan years beginning January 1, 2025, except the plans that do not count service before January 1, 2021, for purposes of participation and vesting, which are effective retroactively.

3. New Employer Match for Student Loan Payments

The SECURE 2.0 Act allows an employer to match an employee’s student loan repayments by making matching contributions to the employer’s defined contribution plan, such as a 401(k) plan. Previously, employers could match only employees’ Roth and pre-tax elective deferrals or after-tax contributions. The match is limited based on applicable elective deferral limits, and the employee’s deferrals and income.

The SECURE 2.0 Act allows an employer to rely on an employee’s own annual certification of the amount of their qualifying student loan payments, which should minimize the administrative burden and risk to employers.

Importantly, the new law addresses how to treat the employer match for student loan payments for nondiscrimination purposes. It states that employer match for student loan payments will not fail to be treated as available to an employee only because the employee does not have a qualifying student loan. It confirms that a plan should not treat an employee’s student loan payments as elective deferrals or contributions to the plan. In addition, it allows a plan to treat all employees who receive employer matches for student loan payments as a separate group for purposes of actual deferral percentage (ADP) testing in any one plan year.

These changes take effect for plan years beginning January 1, 2024 and after.

4. New Starter 401(k) Plans for Employers With No Retirement Plan

The SECURE 2.0 Act creates a new “401(k) deferral arrangement.” It essentially makes a 401(k) plan available to employers that do not maintain any plans that receive contributions or in which benefits accrue for service in a certain year. This will be a new type of plan with certain requirements. Many states have implemented this type of plan, and now the federal government hopes to make this solution helpful to new or small employers.

5. Increased “Catch-Up” Contributions and Modified Required Minimum Distributions (RMDs)

• Catch-Up Contribution Limit Increased to $10,000. Catch-up contributions allow individuals age 50 or older to bypass limits on the amounts participants may contribute and make “catch-up” contributions to increase their retirement savings. Starting in 2025, the SECURE 2.0 Act increases the catch-up contribution limit for plan participants who reach ages 60 to 63 by the end of the tax year in question.

The new catch-up limit will be $10,000 per year for participants in most plans. These new limits will be indexed to inflation for tax years beginning January 1, 2026 and after.

• Workers Earning Over $145,000 Must Make Catch-Up Contributions as Roth Contributions.

The SECURE 2.0 Act requires eligible participants with wages over $145,000 (adjusted for inflation) to make catch-up contributions as Roth contributions in order for the plan to retain its tax-favored status. The plan may allow the participant to change their election to make catch-up contributions if their income increases over the income threshold after the participant made their election initially. This new requirement takes effect for tax years beginning January 1, 2024 and beyond. This will cause many plan participants to address tax questions to the employer and cause future fiduciary concerns.

• Modified RMDs. The new law eases the current rules surrounding RMDs by raising the age for taking RMDs, decreasing the penalty for failing to take RMDs, and eventually eliminating the requirement for participants with Roth 401(k) plan accounts to take RMDs.
  
  • Participants May Wait Longer to Take RMDs. Currently, retirees are required to begin taking distributions of their tax-preferred retirement account balances after they reach age 72. Effective for 2023 and later RMDs, the SECURE 2.0 Act increases this age, which has the effect of delaying the time participants must begin taking their RMDs as follows: (1) participants who reach age 72 after December 31, 2022, and age 73 before January 1, 2033, will have to begin taking RMDs after they reach age 73; and (2) participants who reach age 74 after December 31, 2032, will have to begin taking RMDs after turning 75. These changes take effect for distributions required to be made on January 1, 2023 and after.
  • Lower Tax Penalties for Failure to Take RMDs. The SECURE 2.0 Act reduces the tax penalties associated with failure to take RMDs by half. Currently, a participant who fails to take the RMD must pay a tax penalty equal to 50% of the difference in the RMD and the actual distributions the individual actually took. The new law lowers this penalty to 25%. In addition, a participant may reduce the penalty to 10% by taking advantage of a correction process. These changes take effect for tax years beginning the date the new law is enacted.
  • No RMDs for Roth Portions of Retirement Plans. The SECURE 2.0 Act removes the requirement to take RMDs of Roth portions of qualified plans. This change puts Roth 401(k) plan account participants on the same footing as Roth IRA participants, who were already exempt from taking RMDs for their Roth IRAs. This change takes effect for tax years beginning January 1, 2024 and after. It does not apply to RMDs required for tax years before the effective date but paid after it.
• New Limit for Mandatory Lump Sum Distributions is $7,000.  The SECURE 2.0 Act increases the ceiling for mandatory lump sum distributions from $5,000 to $7,000. The new amount takes effect with distributions made January 1, 2024 and after.

Conclusion

The SECURE 2.0 Act contains a number of broadly applicable changes, apart from the ones in this summary, and many smaller specific changes, that employers may, and in some cases must, incorporate into their plans and plan operations. Employers and plan administrators should consult with their counsel and other advisors to determine which provisions apply to their plans, and how to incorporate them to remain in compliance with this new law.