Much is being written about how SECURE 2.0 affects 401(k) plans, the most popular type of qualified plan today. Certainly there are important changes in store for 401(k) plans, including mandatory auto enrollment for new plans, “Rothification” of contributions, and new design options. However, it is important to be aware that SECURE 2.0 impacts all types of pension plans, including defined benefit plans. Here are some of the changes that sponsors of these plans should keep on their radar.
General Changes. Like 401(k) plans, defined benefit plans must make required minimum distributions once participants reach the triggering age. As for 401(k) plans, the age is raised from 72 to 73 for participants who had not attained age 72 by December 31, 2022 and, beginning in 2024, the maximum involuntary cashout amount for small benefits will increase from $5000 to $7000. Changes in the required minimum distribution rules that permit more flexibility in payments from commercial annuities also apply to defined benefit plans.
Changes Targeted at Defined Benefit Plans. A number of specific provisions of SECURE 2.0 are intended to provide plan sponsors with greater flexibility, but additional requirements and complexity will be added when offering lump sum window benefits.
Interest Credits for Cash Balance Plan Compliance.
Many new defined benefit plans are cash balance plans, in which the benefit is expressed as a notional lump sum. However, these plans must have annuities as their normal form of payment and satisfy the anti-backloading rules that apply to defined benefit plans, which requires projecting interest credits to normal retirement age. The Pension Protection Act allowed cash balance plans to tie their interest credits to a variable rate such as a market index or the rate of return on plan assets. However, IRS rules required the projections to be made using the prior year’s interest rate, which magnified the impact of positive or negative returns in the prior year and could result in the plan’s accruals being treated as impermissibly backloaded. Effective immediately, plans that use variable rate interest credits are permitted to use a reasonable interest rate not exceeding 6% for making these projections, which will permit them to provide higher benefits to older, longer service employees.
New Notice and Disclosure Requirements for Lump Sum Windows.
Many plan sponsors have implemented lump sum windows to allow selected groups of participants to receive their benefits as a lump sum. Due to the differences in how the calculations are made, a plan can save money when lump sums are elected. It also saves on future PBGC premiums. However, some have expressed concerns that participants eligible for these lump sum cashouts are given insufficient information to make informed decisions. For example, in 2015, the GAO released a study in which it reviewed sample participant disclosures given in connection with window programs and found some wanting. The GAO also indicated that oversight was hampered because plan sponsors were not required to provide notice to the enforcement agencies when they implemented lump sum windows.
SECURE 2.0 imposes both new notice and new content requirements for window programs, effective when final regulations are issued. Eligible participants will need to be notified at least 90 days prior to the opening of the window, and the PBGC will have to be notified 30 days in advance. Among the new information that must be provided to participants are an explanation of how the lump sum is calculated, whether it includes an early retirement subsidy, and a statement that commercial annuities may be more expensive than annuities provided by the plan. The advance PBG notice will include the length of the window and descriptions of who is eligible and how the lump sum is calculated. Within 90 days following the window, the Department of Labor and the PBGC must be notified about the participants who accepted the lump sum offer. This new regime for window programs may be the prelude to greater enforcement or regulatory activity.
Transfers of Surplus Assets to Fund Welfare Benefits Extended and Funding Conditions Loosened.
Code Section 420 permits overfunded defined benefit plans to transfer a portion of their excess assets to a 401(h) account dedicated to funding retiree health and welfare benefits without paying tax on the transafer. SECURE 2.0 extends the period during which these transfer are permitted to 2032. It also lowers the minimum funded percentage to engage in these transfers from 125% of accrued benefits to 110%, provided that the amount transferred does not exceed 1.75% of plan assets.
Ending COLA Adjustments to PBGC Premiums.
PBGC variable rate premiums, which are paid on top of the standard premium by plans with unfunded vested benefits, are frozen at the 2023 level, eliminating inflationary indexing.
Additional Information for PBGC Funding Notice
SECURE 2.0 requires that additional more user-friendly information be added to the annual funding notice, which is the primary disclosure document for participants about the funded status of their plan. Beginning with the 2024 year, funding notices will be required to disclosre the average return on assets during the plan year, the percent of liabilities funded, and whether assets are sufficient to pay benefits not guaranteed by the PBGC.
Mortality Assumptions.
Effective immediately, there is a cap on the future mortality improvements that must be considered for purposes of the minimum funding requirements.
There are also provisions of SECURE 2.0 covering ESOPs, different types of IRAs, including SIMPLE IRAs, and 403(b) plans. Those will be the subject of future posts.