Many provisions of the SECURE Act passed at the end of last year will change the way qualified plans are run. Among the most significant changes are provisions creating new distribution options and new death distribution restrictions for qualified plans. Since these changes are effective now, plans should be preparing to comply in operation even though formal amendments are not yet required. However, this will be a challenge due to the need for guidance to answer many questions about how the statutory language is intended to work.
Plan sponsors and recordkeepers need to be aware of the following:
Distributions for Birth or Adoption Expenses
401(k) and other defined contribution plans are now permitted to make distributions of up to $5000 per individual to pay for expenses related to a birth or adoption. The distribution may be made up to one year after the date of the birth or adoption. While these distributions are exempt from the 10% penalty for early distributions and mandatory 20% withholding, they are still subject to regular income tax and are not eligible rollover distributions. However, they may be recontributed to the plan.
These provisions are partially retroactive. Distributions may be made within the one year period following the birth or adoption even if it commenced in 2019. Since the statutory language is not 100% clear, guidance has been requested confirming that these provisions are optional and not mandatory.
Qualified Disaster-Related Distributions
The spending legislation establishes special rules for qualified disaster-related distributions from 2018 through a date 60 days from enactment. Affected participants are entitled to spread out their income tax liability over three years and have an opportunity to recontribute the distributions. They are not subject to the 10% early distribution penalty.
Note that the final regulations on hardship distributions also allow plans to make hardship distributions for federally-declared disasters if the participant lived or worked in the disaster area, and this will remain a plan option even after the SECURE Act provision expires.
Annuity Options for Defined Contribution Plans Encouraged
Now that 401(k) plans are the only retirement plan most employees have, there has been interest in providing lifetime income options through annuities. Defined contribution plans must purchase annuity contracts from outside insurers, and a deterrent has been concern that those running the plan could be sued if the insurer subsequently became insolvent and was unable to make payments. The SECURE Act created a fiduciary safe harbor for those selecting the insurer, and provides a new portability option for plans to distribute annuity contracts when annuity options are terminated.
New Fiduciary Safe Harbor.
The new safe harbor adds a paragraph (e) to Section 404 of ERISA, which sets out fiduciary responsibilities. The statutory safe harbor eliminates a requirement that the fiduciaries do an independent financial review of the insurer and permits the fiduciaries to go through a checklist of requirements. These requirements permit them to rely on the determination of state insurance regulators that the insurer has adequate reserves and on financial examinations by the insurance regulators if done at least every five years. There is no independent duty to investigate the insurer’s financial status so long as the fiduciaries are not aware of contrary information. Plan fiduciaries must still conduct a systematic search for insurers, such as by engaging in a request for proposals (rfp). In order to rely on the safe harbor, plan fiduciaries must also determine that the annuity fees are reasonable. The statutory language does not limit the safe harbor to defined contribution plans.
The safe harbor has been criticized by some commentators for not requiring that the insurer have a minimum financial rating from agencies such as Best that regularly rate insurers.
New Portability Rule.
The SECURE Act also attempts to deal with a problem that arises when a plan that provides annuities changes to a recordkeeper that does not provide annuities. In this situation, the existing contract had to be terminated, potentially subjecting the participants to special fees and penalties. The SECURE Act now permits annuities to be distributed to participants or rolled over to an IRA or other employer plan when the plan eliminates an annuity option. The Act does not specify the permissible payment dates under the annuities, but guidance will probably delay payment to the earliest date the plan would otherwise permit distributions, such as age 59 ½ or termination of employment.
Required Minimum Distributions for All Plans Are Delayed Until Age 72.
Participants who had not attained age 70 ½ by December 31, 2019 may delay the commencement of required minimum distributions until April 1 following their 72nd birthday. As before, if they are not 5% owners, participants who work past age 72 may delay distributions until termination of employment.
The End of Most Stretch Death Distributions in 401(k) (and Other defined Contribution) Plans.
But it was not all good news on the distribution front. When a participant dies, payments to many non-spouse beneficiaries must now be made over a period no longer than 10 years regardless of whether the decedent had commenced benefit payments. The exceptions are death distributions to minor children, disabled beneficiaries, beneficiaries with chronic illness and beneficiaries less than 10 years younger than the decedent.
This rule has a significant impact on IRAs, but also affects all defined contribution plans, which previously could make payouts over any beneficiary’s lifetime. This change makes it desirable for participants to review and, if necessary, to change their beneficiary designations and estate plans.
Changes Affecting Only Defined Benefit Plans.
Earlier in-service payouts from Defined Benefit Plans
The Pension Protection Act of 2006 authorized defined benefit plans to make in-service distributions to participants beginning at age 62. Previously, distributions could not be made to participants while they were still employed prior to normal retirement age, which was generally age 65. The SECURE Act further lowered the age for in-service distributions from defined benefit plans to age 59 ½. These changes encourage phased retirement by enabling participants to continue to work on a reduced schedule while accessing their pensions early to make up for the reduction in current compensation. Allowing in-service distributions remains optional, and plan sponsors who adopt such provisions may impose their own conditions, such as limiting the number of in-service distributions a participant may take.
Actuarial Increases for Delayed Payouts.
If a participant works past age 70 ½, regulations under Code Section 409(a) require that the benefit be actuarially increased during this period. It is not clear whether these actuarial increases for delayed payment will not be required until age 72 now that the required minimum distribution commencement date has changed.
Sponsors and Recordkeepers Need to Act.
Although no plan amendments are required at this time, operational compliance is required. We are awaiting official clarification of how some of these provisions should be applied in practice. Among the changes that will be required to administer plans correctly in 2020 will be revised distribution forms, changes to recordkeeping systems, updates to the plan website, additional training for call center employees and revised summary plan descriptions. Although the statute protects good faith compliance with the SECURE Act pending official guidance, there is a real need for prompt guidance to answer the many questions raised about the changes by the sponsors and plan service providers who must implement them.