IRS Provides Guidance on Hodgepodge of Secure 2.0 Provisions

The US Internal Revenue Service (IRS) released a notice providing guidance on various provisions of the SECURE 2.0 Act of 2022 (SECURE 2.0). Some of the topics touched on in the guidance include automatic enrollment, the “Rothification” of employer contributions, de minimis financial incentives, amendment deadlines, and other provisions as described in more detail below.

The IRS on December 20, 2023 issued IRS Notice 2024-02 (the Notice), which provides guidance on selected provisions of SECURE 2.0. The Notice was issued just days before some of the provisions were first effective and includes guidance on a wide range of matters, including the following:

• Automatic enrollment requirements for new plans established after the enactment of SECURE 2.0
• Changes to small employer pension credit
• Military spouse retirement eligibility credit for small employers
• De minimis financial incentives to encourage retirement plan participation
• SIMPLE (Savings Incentive Match PLan for Employees) individual retirement account (IRA) and SIMPLE 401(k) contribution limit increases
• The exception to the 10% tax for terminally ill participant withdrawals
• The ability to terminate SIMPLE IRAs to establish safe harbor 401(k) plan
• Cash balance interest credit projections for anti-backloading provisions
• Automatic enrollment error corrections for 401(k) plans
• Amendment deadline extensions for adopting amendments to comply with SECURE 2.0 and other recent new law changes
• The ability for employees to designate IRA or Roth IRA for SIMPLE IRA/SEP; and
• The optional “Rothification” of employer matching and/or nonelective contributions.

This LawFlash focuses on the changes most relevant to large plan sponsors with more than 100 participants—i.e., automatic enrollment changes, de minimis financial incentives, an exception to the 10% tax for terminally ill participant withdrawals, an automatic enrollment error correction, the Rothification of employer contributions, and amendment deadlines extensions.

Automatic Enrollment

SECURE 2.0 generally requires that a 401(k) or 403(b) plan established after December 29, 2022 must automatically enroll employees—beginning the first plan year beginning after December 31, 2024—at a rate of no less than 3% and no more than 10% and automatically escalate employees by an additional 1% per year up to a rate that is no less than 10% and no more than 15%. (Please see our LawFlash for more specific details about this requirement, investment and withdrawal requirements, and exceptions.) The Notice provides helpful clarifications about the application of these rules to a number of common plan scenarios, as follows:

• Application to new plan types: The SECURE 2.0 automatic enrollment requirements apply to starter 401(k) arrangements and deferral-only 403(b) plans, unless one of the generally applicable exceptions under the automatic enrollment requirements applies (e.g., an exception to automatic enrollment for new or small businesses).
• Application to plans adopted (but not effective) before SECURE 2.0: New plans are subject to the automatic enrollment requirements based on the plan's initial adoption date, rather than its initial effective date. This means that a plan that was first adopted before the December 29, 2022 enactment of SECURE 2.0 but was not first effective until January 1, 2023 or a later date is not subject to the automatic enrollment requirements.
• Plan mergers: The new SECURE 2.0 automatic enrollment requirements raise interesting and novel questions about how (or whether) the rules may apply to plans that are merged together—particularly when one plan is a "new plan" (adopted after December 29, 2022) subject to the automatic enrollment requirements, and the other plan is an "existing plan" (adopted before December 29, 2022) that is not subject to the automatic enrollment requirements. Examples of how the rules may apply to particular situations include the following:
  • As expected, the Notice confirms that if two new plans are merged together, the surviving plan will continue to be subject to the automatic enrollment rules; similarly, the Notice confirms that if two existing plans merge together, the surviving plan is not subject to the automatic enrollment requirements after the merger
  • Except for certain situations involving a corporate transaction as described in the next point, if a new plan and an existing plan merge together, the surviving plan will be treated as a new plan that is subject to the automatic enrollment requirements; this is true regardless of whether the new plan or the existing plan is designated as the surviving plan of the merger
  • If in connection with a corporate transaction described in Internal Revenue Code Section 410(b)(6)(C), a new plan and an existing plan are merged together and the existing plan is designated as the surviving plan, the surviving plan can continue to be treated as an existing plan that is not subject to the automatic enrollment requirements; to qualify for this transaction relief, the plans must be merged before the end of the Code Section 410(b)(6)(C) transition period (the end of the plan year following the plan year of the corporate transaction) and the existing plan must be the surviving plan of the merger
  • If a single employer sponsors a new plan that is merged into a multiple employer plan with one or more employers that are not subject to the automatic enrollment requirements, the ongoing plan—with respect to the single employer's new plan—continues to be subject to the automatic enrollment requirements, but the merger would not affect the other participating employers that are not subject to the automatic enrollment requirements
• Spinoffs: A plan that is spun off from a single-employer existing plan will not be subject to the automatic enrollment requirements, which suggests that the IRS views—for purposes of the automatic enrollment requirements—a spinoff as a continuation of the pre-spinoff plan, not the establishment of a new plan and transfer of assets. In the case of a spin off from a multiple employer plan, the spun-off plan generally will continue to receive the same treatment (i.e., as either a new plan or an existing plan) that applied to the plan and employer pre-spinoff.

De Minimis Financial Incentives

Prior to SECURE 2.0, the so-called "contingent benefit rule" prohibited employers from providing benefits or incentives—other than matching contributions—to employees who choose to make deferrals under a 401(k) or 403(b) plan. SECURE 2.0 created an exception to the contingent benefit rule and allows employers to offer de minimis financial incentives—funded from a source other than the plan—to employees who make contributions but leave important unanswered questions, including to the extent to where any incentive would be considered “de minimis” for this purpose.

The Notice addresses some of the following previously-unanswered questions:

• Amount of the de minimis incentive: The amount or value of the de minimis financial incentive can’t be more than $250
• Type of incentive: Gift cards are identified in the Notice as an example of a possible de minimis incentive, and the Notice expressly provides that matching contributions cannot be a de minimis financial incentive; otherwise, the Notice does not identify or define permissible or prohibited types of incentives
• Eligibility for incentive: The incentive can only be offered to employees without a deferral election in place at the time of the offering; this means that an employer generally cannot offer an incentive to employees to increase their current elections.
• Form of incentive: In order to incentivize employees to continue to make deferrals after the original election, the employer can pay the de minimis incentive in installments (even crossing more than one year) contingent on the employee’s continued deferrals, rather than a single payment
• Tax treatment: As expected, de minimis incentives provided by the employer are treated as remuneration that is includible in an employee's taxable gross income and wages and subject to all applicable withholding and reporting requirements, unless the incentive satisfies an exception under the Internal Revenue Code (e.g., as a de minimis fringe benefit); the Notice does not provide detailed guidance on these issues, but specifically notes that a $200 gift card would not be excludable from gross income and wages as a de minimis fringe benefit because it is a cash equivalent

Please note that a “de minimis financial incentive” that is designed to satisfy the SECURE 2.0 rule is different from a “de minimis fringe benefit” for purposes of payroll taxes. As noted above, a “de minimis financial incentive” will be subject to the Federal Insurance Contributions Act (FICA), Federal Unemployment Tax Act (FUTA), and Federal income tax withholding (FITW) if it is not also structured to comply with the de minimis fringe rules or other fringe benefit exceptions.

For example, the $200 gift card described above would be subject to FICA, FUTA, and FITW as it is a cash equivalent and too large to qualify for the de minimis fringe benefit exception, and because the employer cannot withhold from the gift card amount, the employer would need to reduce the employee’s other compensation by the amount of the withholding.

Plan sponsors may wish to consider designing the de minimis financial incentive to comply with one of the other fringe benefit exceptions (e.g., by offering retirement planning sessions or tickets to one-time sporting or theater events) or clearly communicate to employees that there will be an impact on their cash wages so that they are not taken by surprise.

Exception to 10% Tax for Distributions to Terminally Ill Participants

Effective for distributions on or after December 29, 2022, SECURE 2.0 provides an exception to the 10% early distribution penalty tax for terminally ill participants who take a distribution. This new exception does not create a new distributable event, and a participant must otherwise be eligible to take a distribution under the plan's terms.

Terminally ill participants may recontribute amounts distributed pursuant to this exception to a qualified retirement plan that accepts rollovers over a three-year period. The Notice clarifies several questions relating to this new exception as follows:

• Eligible plans: The exception applies to distributions from any tax-qualified retirement plan under 401(a) (including defined benefit plans), 403(b) plans, and IRAs, but not governmental 457(b) plans.
• Provision is optional for plans: There is no requirement that a plan offer a specific distribution feature to terminally ill participants. Even if a plan does not offer such a distribution feature, a terminally participant can still take advantage of the exception by claiming it on the participant's personal income tax return. As such, while offering the distribution feature through a plan may make it somewhat more convenient—particularly when it comes to the recontribution of the distribution—terminally ill participants will be able to take advantage of the exception in any case.
• Eligibility for the exception: To qualify for the exception, a participant must obtain a certification from a doctor of medicine or osteopathy legally authorized to practice medicine and surgery in the state where the certification is made before the distribution; a participant may not retroactively qualify for the exception after the distribution is made. Further, an employee cannot make their own certification, even if they are a physician, and the certification must:
  • state that the participant’s illness or physical condition is terminal and can reasonably be expected to result in death 84 months or less after the certification is made;
  • describe the evidence used to determine the participant has a terminal illness (the evidence itself does not need to be included, but the employee needs to retain it for their tax records);
  • include the name and contact information of the physician;
  • include the date the evidence was reviewed or examined and the date the certification was signed;
  • be signed by the physician; and
  • attest that the physician drafted the narrative based on their examination of the patient and/or review of evidence provided by the patient.
• No amount limits: This exception applies to all distributions to a participant who satisfies the terminal illness exception requirements; there is no limit on the amount that can be subject to this exception.
• Recontribution: Subject to similar recontribution rules as established for other special distribution types (e.g., the recontribution rules for qualified birth and adoption distributions), a terminally ill participant may recontribute amounts to an employer's plan that accepts rollovers or, if the plan does not allow terminal illness distributions or accept rollovers, the participant may recontribute the distribution to an IRA.

Cash Balance Interest Crediting Rate for Anti-Backloading Provisions

Before SECURE 2.0, cash balance plans with variable interest crediting rates that provided increased pay credits based on age or service risked violating the anti-backloading rules if the interest crediting rates fell below certain levels. To avoid this risk, some cash balance plans added minimum interest crediting rates to ensure that the interest crediting rate never dropped below this floor. SECURE 2.0 eliminates the need for these minimum interest crediting rates because it provides that a reasonable projection of the interest crediting rates can be used for purposes of the anti-backloading rules (so long as the rate does not exceed 6%).

Given that a minimum interest crediting rate is no longer required, the Notice provides that:

• Cash balance plans that provide for increased pay credits based on age and service (or are implementing these credits as part of the amendment) can amend the plan to reduce or remove an existing interest credit floor, or change to an investment-based rate, or change from a fixed rate to variable rate, but the new variable rate cannot be more than "X" less than the maximum variable interest credit rate of the same type, where "X" is the amount the fixed rate was less than 6%.
• While SECURE 2.0 provides anti-cutback relief for an amendment that removes the minimum interest crediting rate for interest credits, the Notice makes it clear that the amendment cannot reduce participants' accrued benefits. As such, if a participant's cash balance account reflects minimum interest credits before the effective date of the amendment—or before the amendment was adopted, if earlier—the cash balance account balance must be preserved.

According to the Notice, the IRS does not expect this SECURE 2.0 provision to apply to hybrid plans that are not cash balance (e.g., pension equity plans).

Automatic Enrollment Error Correction

SECURE 2.0 made permanent a temporary safe harbor for plans with automatic contribution features to correct certain operational errors involving elective deferrals without the need for an employer contribution for “missed deferrals” (employer contributions to correct missed matching contributions and earnings must still be made).

Before SECURE 2.0, the temporary safe harbor for correcting these sorts of operational errors was set forth in the IRS's Employee Plans Compliance Resolution System (EPCRS) and was set to expire on December 31, 2023. Please see our earlier LawFlash describing the permanent establishment of this safe harbor in more detail. The Notice offers some clarification on how to qualify for the safe harbor correction exception.

Terminated Employees

SECURE 2.0 clarified that the automatic enrollment safe harbor correction is available for terminated employees. The Notice further clarifies that the participant notice that is required as part of the correction does not need to include information that would be inapplicable to a terminated participant (e.g., there is no need to include a statement that a terminated participant can increase their contribution elections).

Application of SECURE 2.0 Versus EPCRS

There is some potential overlap between the temporary safe harbor correction rules in EPCRS and the permanent safe harbor correction rules in SECURE 2.0. The Notice clarifies that the SECURE 2.0 rules apply to any elective deferral error where the deadline to start corrective deferrals occurs after December 31, 2023.

In general, the date that correct deferrals are required to begin is the earlier of (1) the first payment of compensation after the nine-and-a-half month period after the end of the plan year in which the implementation error first occurred (October 15 of the next plan year for calendar year plans) or (2) the first payment of compensation on or after the last day of the month following the month the employee notified the employer of the error. This means that some errors that began in 2023 or later may be subject to the SECURE 2.0 provisions even if they first occurred before December 31, 2023.

Deadline for Deposit of Matching Contributions

Under the SECURE 2.0 safe harbor, matching contributions must be made by the last day of the sixth month following the date correct deferrals begin (or would have begun, for a terminated employee).

However, if the error began on or before December 31, 2023, the plan has until the end of the third plan year following the year the error occurred to deposit the matching contributions, following the EPCRS timing requirement. This is likely helpful relief to plan sponsors that corrected 2023 elective deferral failures under EPCRS.

Rothification of Matching Contributions and Non-Elective Contributions

SECURE 2.0 allows plan sponsors to offer participants the opportunity to choose to receive fully vested employer contributions to a Roth, rather than pre-tax basis. Please see our prior LawFlash describing the optional Rothification of matching and non-elective contributions for more details around this provision.

Although this optional Rothification feature for employer contributions was available immediately following SECURE 2.0's December 29, 2022 enactment, plan sponsors and providers have been reluctant to adopt this feature due to the many open taxation, reporting, and other administrative issues. The Notice addresses many of these open questions.

Election Procedures

Applying similar rules to those that apply to the elective deferral of Roth contributions, the Notice makes clear that a Rothification election for employer contributions must be made before the contributions are allocated to the participant’s account and, once made, is irrevocable. Further, participants must be allowed to change the designation for future contributions at least once each plan year.

Full Vesting Required

The Notice provides that the Rothification election can only be made for employer contributions that are fully vested. However, the Notice helpfully provides that complying with this full vesting requirement will not result in the plan failing to satisfy the applicable nondiscrimination requirements relating to the offering of the optional Rothification feature (i.e., the requirement to offer benefits, rights, and features on a nondiscriminatory basis).

Tax and Reporting Treatment

The Notice makes clear that Rothified employer contributions are included in an employee's gross income in the year the employer contributions are allocated to the employee's account (and that this is true even if the contributions relate to the prior tax year). However, the Notice provides that the Rothified employer contributions are not subject to income tax withholding and are not included in wages for FICA or FUTA tax purposes for 401(a) and 403(b) plans (though in certain situations FICA may apply to certain governmental employees participating in governmental 457(b) plans).

Accordingly, for most employees, Rothified employer contributions would not be reported on an employee's Form W‑2. Rather, the Notice provides that Rothified employer contributions must be reported and taxed in the same manner as in-plan Roth conversions. That is, the Rothified employer contributions would be reported on a Form 1099-R issued for the year in which the contributions are allocated to the employee's account. The employee would then be responsible for reporting the Rothified contributions on their personal income tax return for the year and paying all required taxes at that time.

Interaction With Other Roth Features

While it is not entirely clear why a plan sponsor would want to do this, the Notice provides that it is permissible to offer Rothification of employer contributions even if the plan does not offer employees the ability to make Roth elective deferrals. However, in-plan Roth conversions are only permissible if the plan permits Roth elective deferrals, Rothification of employer contributions, or both.

Amendment Deadline Extension

The Notice further extends the deadlines for plans to adopt amendments for a broad range of recent law changes, including the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE 1.0), certain provisions of the Coronavirus Aid, Relief, and Economic Security Act of 2020 (CARES Act) (required minimum distribution relief, loan extension and amount increase, coronavirus-related distributions), certain provisions of the Bipartisan American Miners Act of 2019 (lowering age for in-service distributions from defined benefit plans), certain provisions of the Disaster Tax Relief Act of 2021, and SECURE 2.0. The deadlines to adopt required or discretionary amendments under these provisions are extended as follows:

• For non-collectively bargained qualified plans: December 31, 2026
• For collectively bargained plans: December 31, 2028
• For governmental qualified plans and public school 403(b) plans: December 31, 2029
• For governmental 457(b) plans: The first day of the plan year that is more than 180 days after the date of notification that administered inconsistently with 457(b) requirements

While this generous amendment relief is welcome, it may lead to a significant lapse of time between the implementation of changes and the ultimate adoption of the required amendments for such changes. As such, plan sponsors that wait until closer to the deadline to adopt the necessary amendments should consider carefully and contemporaneously memorializing any changes in plan design and administration as they are implemented.

CONCLUSION

The Notice provides helpful guidance on an assortment of SECURE 2.0 provisions, making them more accessible to plan sponsors that may be interested in adopting them. However, some uncertainty and administrative challenges remain. As such, plan sponsors should consider discussing the application of these provisions with recordkeepers, providers, and legal counsel before implementing.