The reach of SECURE 2.0 is extensive. Its general provisions affect all types of retirement plans, but SECURE 2.0 also has some provisions targeted at plans subject to their own set of statutory and regulatory requirements. Sponsors of 403(b) plans, ESOPs and employers participating in or considering joining multiple employer plans should keep these changes on their radar.
403(b) Plans.
403(b) plans, also known as tax sheltered annuities, are sponsored by not-for-profits and other entities such as churches, public schools and hospitals. They have long been subject to special rules, such as a universal eligibility rule for coverage, special catch-up contribution limits, and special rules for Section 415 calculations, but the trend in recent years is to subject them to many of the same general rules as 401(k) plans. SECURE 2.0 continues this trend.
Hardship Withdrawals.
One of the remaining major differences between 403(b) plans and 401(k) plans has been in the funds that may be made available for hardship distributions. 401(k) plans were not permitted to distribute earnings on elective contributions, or assets attributable to employer safe harbor matching or nonelective contributions, QNECs and QMACs. As a result of 2018 legislation and final IRS regulations, these restrictions were eliminated. However, the legislation did not amend provisions of the Internal Revenue Code prohibiting 403(b) plans from distributing earnings on employee contributions on account of hardship and prohibiting 403(b) custodial accounts from including amounts attributable to employer contributions in hardship distributions. Beginning in 2024, these additional contribution sources are available for hardship distributions from 403(b) plans. Other general changes, such as the ability to rely on participant certifications in making hardship distributions, also apply to 403(b) plans.
Participation in MEPs and PEPs Becomes an Option.
Effective in 2023, SECURE 2.0 also permits 403(b) plans to participate in multiple employer plans (MEPs). These are plans in which unrelated employers who may or may not share a common business bond participate, and include as a subset pooled employer plans, or PEPs, a special kind of multiple employer plan created by the first SECURE Act and available since 2021. These plans allow employers to offload administrative responsibility and to benefit from economies of scale. PEPs are required to be run by a Pooled Plan Provider, a named fiduciary registered with the Department of Labor, and the fiduciary exposure of participating employers is limited by statute. 403(b) plans could also rely on an exception to the “one bad apple rule’ that provides that one employer’s qualification issue could no longer taint qualification of the entire plan. Sponsors of smaller 403(b) plans in particular may want to explore these options as ways to ease their administrative and investment responsibilities.
Attempt to Make Collective Trusts Available.
An additional change in SECURE 2.0 that was intended to expand investment options for 403(b) plans by permitting them to invest in collective trusts may have to be placed on hold pending further Congressional or agency action. Collective trusts have become an increasingly popular alternative to mutual funds for 401(k) plans as they may have lower fees and/or sliding scales in which the fees are reduced as assets invested by a plan increase. However, the final language in SECURE 2.0 did not provide a fix for a securities law issue that could subject collective trusts to registration requirements if 403(b) plans were permitted to participate. This appears to have been an oversight in the rush to get the legislation passed by year end, and sponsors of 403(b) plans will have to see if a fix becomes available.
How will Auto-Enrollment Work for 403(b)’s?
New 403(b) plans will be subject to SECURE 2.0’s mandatory auto enrollment and auto-escalation requirements when they become effective. Under current law, such plans are already subject to a universal availability requirement that, with certain exclusions, requires all employees to be offered the opportunity to contribute. These exclusions are not the same as those that apply for coverage testing of 401(k) plans. Guidance will be needed on which exclusions will be available to 403(b) plans subject to auto-enrollment and how these provisions will work together.
MEPs and PEPs.
PEPs have been subject to some special statutory requirements, including the requirements to have a bank or trust company as trustee. SECURE 1.0 also required the trustee to be responsible for monitoring contributions and collecting delinquent contributions, a responsibility some potential bank trustees were reluctant to undertake. SECURE 2.0 provides PEPs with greater flexibility by permitting a plan to name any designated fiduciary other than an employer participating in the plan to be responsible for collecting contributions and for procedures for collecting delinquent contributions. This provision is effective in 2023.
Another special rule that applies to MEPs relates to grandfathering of plans for purposes of the mandatory auto-enrollment requirement. The new requirement will not apply to plans in existence when SECURE 2.0 was enacted. For this purpose, a plan adopted after enactment that joins a MEP that pre-dates SECURE 2.0 will not be treated as grandfathered.
SECURE 2.0 also directs the Department of Labor to provide periodic reports beginning in 2027 on how PEPs may be improved to better serve and protect retirement plan participants.
Groups of Plans.
SECURE 1.0 allowed groups of plans with the same recordkeeper and investments to file one combined Form 5500. The plans for which this option is available are not limited to plans within the same controlled group. However, questions have arisen how ERISA’s plan audit requirement, which applies to plans with 100 or more participants, applies in that situation. SECURE 2.0 makes clear that the audit requirement applies only to those plans who would be subject to the audit requirement if filing a separate Form 5500, and not to all of the plans in the reporting group.
ESOPs.
In addition to facilitating employee ownership, employee stock ownership plans provide special tax benefits beyond those of other qualified plans. SECURE 2.0 contains two provisions that ESOP proponents have sought, but they won’t become applicable to ESOPs until after 2027. SECURE 2.0 also directs the Department of Labor to establish an Employee Ownership Initiative within the Department of Labor to encourage and provide grants to state programs on employee ownership, which should encourage ESOP formation.
ESOP Appraisals.
Most ESOP investigations and litigation revolve around the issue of whether the ESOP paid more than fair market value for non-publicly traded employer stock, which is a prohibited transaction. Established ESOPs of private companies must also have annual independent appraisals as a qualification requirement. While the Department of Labor has entered into settlements with ESOP trustees which unofficially set out future valuation processes the DOL would find acceptable (See, for example, the DOL’s settlement with Great Banc and a later agreement with Reliance Trust Company involving Kurt Manufacturing), there are no regulations on appraisal standards or indicating how appraisals should be made. SECURE 2.0 requires the Secretary of Labor to issue formal guidance on standards and procedures to establish the fair market value of shares in ESOP transactions, which should clarify the law for responsible fiduciaries.
Expanded Definition of Publicly-Traded Securities.
Beginning in 2028, SECURE 2.0 allows the securities of businesses with stock quotations by at least 4 dealers continuously published on a regulated securities exchange, if they are not a shell or blank check company, and satisfy public float and minimum value and percentage requirements for the stock, to be treated as publicly-traded. The provision amends the diversification requirement in Code Section 401(a)(35), but the Finance Committee description suggests that a broader application, such as to the annual appraisal requirement applicable to ESOPs with non-publicly-traded securities, may have been intended. A technical correction may be necessary to clarify the scope of this provision..
Owner Buyouts.
Much of the ESOP formation activity today occurs in connection with owner buyouts, particularly on retirement. Section 1042 of the Internal Revenue Code permits a selling shareholder of a Subchapter C corporation to defer tax on gains from the sale of stock to an ESOP if the proceeds are invested in qualifying replacement property and the ESOP owns at least 30% of the corporation’s stock after the sale. However, this tax treatment is not available when the business is a Subchapter S corporation, and some businesses have converted to C corporations just to take advantage of the owner tax deferral. Beginning in 2028, SECURE 2.0 permits owners selling their shares to Subchapter S corporation ESOPs to take advantage of a limited deferral of their gain on the sale. The deferral is capped at 10% of the proceeds, whereas there is no percentage limit applicable to gain from sales to C Corporation ESOPs.
These specialized plan rules in SECURE 2.0 will, in several cases, require clarification from Congress or the responsible administrative agencies before plan sponsors can evaluate their potential usefulness and impact