IRS Issues Guidance for Retirement Plan Sponsors Under SECURE 2.0

On December 20, 2023, the IRS released Notice 2024-02 (the Notice), providing clarifications on certain provisions of the SECURE 2.0 Act of 2022 (SECURE 2.0) affecting qualified plans (especially 401(k) and 403(b) plans). This Advisory serves as an update to our previous Advisory outlining key provisions of SECURE 2.0. The following is a summary of some of the key issues discussed in the Notice.

Expanding Automatic Enrollment

Generally, SECURE 2.0 mandates an automatic enrollment feature for new 401(k) plans established on or after December 29, 2022. However, certain plans established before that date (pre-enactment plans) are exempt from the mandate.

• Establishment Date: The establishment date of a plan is the date when plan terms for 401(k) deferrals are initially adopted, even if the effective date of such 401(k) is later than such adoption date.
• Merging Pre-Enactment Plans: When two single employer pre-enactment 401(k) plans merge, the merged plan retains its exemption from the automatic enrollment mandate.
• Merging Pre-Enactment Plan With a Post-Enactment Plan: When a single employer pre-enactment plan merges with a single employer plan established on or after December 29, 2022, the merged plan will not be treated as a pre-enactment plan, except under certain conditions such as post-corporate transaction mergers in which the pre-enactment plan is designated as the ongoing plan.
• Spun-Off Plans: If a single employer pre-enactment plan undergoes a spin-off, the spun-off plan will continue to be treated as a pre-enactment 401(k) plan.
• Application to 403(b) Plans: 403(b) plans are subject to the same automatic enrollment mandate, except for those established before December 29, 2022, regardless of when the deferral feature is added.
• Starter 401(k) Plans: The automatic enrollment mandate generally applies to “starter 401(k) plans” for plan years beginning after December 31, 2024.

Self-Correction for Automatic Enrollment

The IRS Employee Plans Compliance Resolution System (EPCRS) set forth in Revenue Procedure 2021-30 provided a safe harbor method for correcting reasonable errors in implementing automatic enrollment features (e.g., failure to enroll an employee under an automatic contribution or escalation feature). An employer could correct an implementation error by beginning to withhold correct deferrals generally by nine and one-half months after the end of the plan year in which the implementation error occurred, making a corrective allocation of matching contributions on employee missed deferrals and satisfying certain notice requirements. This safe harbor correction method was scheduled to expire on December 31, 2023, but SECURE 2.0 codified the safe harbor correction method. The Notice specifies that corrections may generally be made for both active and terminated employees and that the SECURE 2.0 safe harbor correction method for missed deferrals is generally effective for implementation errors with correction deadlines after December 31, 2023.

If an affected individual would have been entitled to additional matching contributions had the implementation error not occurred, a corrective allocation of the additional matching contributions (adjusted for earnings) must be made within a “reasonable period” which generally means that the contributions are made by the last day of the sixth month following the month in which correct elective deferrals begin (or would have begun for terminated employees). However, in the case of a corrective allocation of matching contributions made with respect to an implementation error occurring before 2024, corrective allocations made by the end of the third plan year following the year in which the error occurred will be treated as having been made within a “reasonable period.”

Roth Contributions

Under SECURE 2.0, plan sponsors are allowed to permit participants to designate employer matching or nonelective contributions as Roth contributions. The Notice provides answers to some of the questions on this provision, including timing of participant elections, income inclusion, and Form 1099-R reporting. The Notice states that employer contributions may only be designated as Roth contributions if a participant is fully vested in that type of contribution at the time it is allocated to the participant’s account.

De Minimis Incentives

SECURE 2.0 allows employers to offer "de minimis" financial incentives (not paid for with plan assets) to encourage plan participation. According to the Notice, incentives cannot exceed $250 in value. These incentives can only be offered to employees without a deferral election in place, except for de minimis financial incentives made in installments and paid contingent on continued deferral. Matching contributions do not qualify as de minimis financial incentives. De minimis financial incentives are generally taxable and subject to withholding and reporting requirements.

SIMPLE and SEP Plans

• Contribution Limits for SIMPLE Plans. SECURE 2.0 increased salary deferral and employer contribution limits for certain SIMPLE IRAs and SIMPLE 401(k) plans. The Notice provides that the increased deferral limits apply to an employer that did not establish or maintain a 401(a) plan, 403(a) annuity plan, or 403(b) plan covering substantially the same employees in the three-year taxable period before the first year the employer maintained the SIMPLE plan. The increased deferral limits apply automatically to an eligible employer with not more than 25 employees who received at least $5,000 of compensation for the preceding calendar year, and by employer election in the case of any other eligible employer. The Notice clarifies how the employee count is calculated and provides a two-year grace period when the employee count is exceeded. Employers who make an election to apply the increased deferral limits also must make increased matching contributions or increased nonelective contributions. Employers who make the election for a year must do so before providing the annual employee notice regarding salary reduction agreements for the year and must notify employees of the increased deferral and employer contribution limits.
• SIMPLE IRA Plan Termination. Prior to SECURE 2.0, employers could not terminate their SIMPLE IRA plans mid-year, and rollovers from terminated IRA plans were severely limited for participants with less than two years of participation. SECURE 2.0 allows an employer to terminate a SIMPLE IRA plan mid-year and replace it with a safe harbor 401(k) plan for the plan year beginning after December 31, 2023. The Notice provides that an employer can terminate a SIMPLE IRA by taking formal action specifying a termination date. Employees must receive a 30-day notice before termination which must include a statement that no salary reduction contributions may be made with respect to compensation paid after the termination date. Distributions from a terminated SIMPLE IRA plan within the first two years of an individual’s participation can be rolled over to certain 401(k) and 403(b) plans. The Notice also includes guidance for modified salary deferral limits and notice requirements for the year in which a SIMPLE IRA is replaced by a safe harbor 401(k) plan mid-year.
• SIMPLE and SEP Roth IRAs. SECURE 2.0 permits an employee who participates in a SIMPLE IRA plan or simplified employee pension arrangement (SEP) to designate a Roth IRA to which contributions under the SIMPLE IRA plan or SEP are made. The Notice clarifies that employers are not required to offer a Roth contribution option under their SIMPLE IRA plans and SEPs and provides details regarding when an employee may make the Roth contribution election and whether contributions are subject to income and employment tax withholding.

Additional Provisions

• Terminal Illness Distribution. SECURE 2.0 permits terminally ill individuals to withdraw amounts early from their retirement accounts without facing the 10% tax penalty. The Notice confirms that while SECURE 2.0 created an exception to the early withdrawal penalty, it did not create a new in-service distribution option. Therefore, a distribution for terminal illness may only be made if the individual has separated from employment or is otherwise eligible for an in-service distribution, such as a hardship or disability distribution. The Notice defines a “terminally ill individual” and includes details regarding a required physician certification of terminal illness. Qualified plans, including 401(a) plans, 403(a) annuity plans, 403(b) annuity contracts, and IRAs, may permit terminally ill distributions.
• Military Spouse Credit for Small Employers. The Notice provides guidance on a new tax credit for small employers providing retirement benefits to military spouses through an eligible defined contribution plan, with eligibility to claim the tax credit extending up to a three-year credit period.
• Cash Balance Plan Accrual Rule. The Notice provides guidance on SECURE 2.0 changes to defined benefit accrual requirements for cash balance plans with variable interest crediting rates.
• Plan Amendment Deadline. The IRS has clarified the deadlines for retirement plan amendments: Qualified plans have until December 31, 2026, with exceptions for governmental and collectively bargained plans, which must be amended by December 31, 2029 and December 31, 2028, respectively; 403(b) plans must be amended by December 31, 2026, with exceptions for public school and collectively bargained 403(b) plans, which must be amended by December 31, 2029 and December 31, 2028, respectively; and IRA trust agreements or annuity contracts must be amended by December 31, 2026, unless the IRS issues guidance setting a later date.

Further Considerations

The Notice states that the IRS anticipates issuing further SECURE 2.0 guidance. We will continue to monitor the status of the guidance.

© Arnold & Porter Kaye Scholer LLP 2024 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.