Setting Every Community Up for Retirement Enhancement Act (SECURE Act)

Setting Every Community Up for Retirement Enhancement Act (SECURE Act)

Congress recently passed-and the President signed into law-the SECURE Act – Setting Every Community Up for Retirement Enhancement Act, landmark legislation that affects the rules for creating and maintaining employer-provided retirement plans. The SECURE Act became effective January 1, 2020.

The following provides highlights of the most notable changes, as well as what the legislation means to current savers and future retirees:

 

Long-term Part-time Workers Can Participate in 401(k) Plans

Under pre-Act law, employers generally may exclude part-time employees (employees who work less than 1,000 hours per year) when providing a defined contribution plan to their employees. A qualified retirement plan can generally delay participation in the plan based on attainment of age or completion of years of service but not beyond the later of completion of one year of service (that is, a 12-month period with at least 1,000 hours of service) or attainment of age 21. 

A plan can provide that an employee is not entitled to an allocation of employer non-elective or matching contributions for a plan year unless the employee completes either 1,000 hours of service during the plan year or is employed on the last day of the year even if the employee previously completed 1,000 hours of service in a prior year. Once an employee has completed 1,000 hours of service during a plan year, an employee cannot be precluded from making elective deferrals based on a service requirement.

Qualified retirement plans are subject to requirements as to the period of service after which a participant’s right to his or her accrued benefit must be non-forfeit able (that is, “vested”). Generally, a year of vesting service is only required to be credited if an employee completes 1,000 hours of service during the year. 

New law. For plan years beginning after Dec. 31, 2020, the SECURE Act requires a 401(k) plan to allow an employee to make elective deferrals if the employee has worked at least 500 hours per year with the employer for at least three consecutive years and has met the age requirement (age 21) by the end of the three consecutive year period. For determining whether the three-consecutive-year period has been met, the 12-month periods beginning before Jan. 1, 2021 will not be taken into account. This provision doesn’t apply to collectively bargained plans.

A “long-term part-time employee” who has completed this period of service, cannot be excluded from the plan because the employee has not completed a year of service as defined under the participation requirements (a 12-month period with at least 1,000 hours of service). Once a long-term part-time employee meets the age and service requirements, the employee must be able to commence participation no later than the earlier of (1) the first day of the first plan year beginning after the date on which the employee satisfied the age and service requirements or (2) the date 6 months after the date on which the individual satisfied these requirements. Employers may, but are not required to, allow long-term part-time employees to participate in the nondiscrimination design based safe harbors (including the automatic enrollment safe harbor) for testing the amount of contributions benefits under a qualified retirement plan. If an employer does allow a long-term part-time employee to participate in an automatic enrollment 401(k) plan, that employee would have elective deferrals automatically made at the default rate unless the employee affirmatively elects not to make contributions or to make contributions at a different rate.

The SECURE Act does not require a long-term part-time employee to be otherwise eligible to participate in the plan. Thus, the plan can continue to treat a long-term part-time employee as ineligible under the plan for employer non-elective and matching contributions based on not having completed a year of service. However, if a plan does provide employer contributions for long-term part-time employees, it must credit, for each year in which the employee worked at least 500 hours, a year of service for purposes of vesting in any employer contributions.

 

Penalty-free Plan Withdrawals for Births or Adoptions

A distribution from a qualified retirement plan, a tax-sheltered annuity plan, an eligible deferred compensation plan of a State or local government employer, or an IRA, is generally included in income for the year distributed. Unless an exception applies, a distribution before age 59½ also is subject to a 10% additional tax (early withdrawal penalty) on the amount includible in income. 

New law. For distributions made after Dec. 31, 2019, the SECURE Act provides for penalty-free withdrawals from retirement plans for a “qualified birth or adoption distribution” – namely, a distribution to an individual if made during the one-year period beginning on the date on which a child of the individual is born or on which the legal adoption by the individual of an eligible adoptee is finalized. An eligible adoptee means any individual (other than a child of the taxpayer’s spouse) who has not attained age 18 or is physically or mentally incapable of self-support. The maximum aggregate amount of a qualified birth or adoption distribution by any individual with respect to any birth or adoption is $5,000, applied on an individual basis (so each spouse separately may receive a $5,000 of qualified birth or adoption distributions). Taxpayers must include the name, age, and taxpayer identification number (TIN) of the child or eligible adoptee on their tax return.

 

Increase in Age for Required Beginning Date for Mandatory Distributions

Employer-provided qualified retirement plans (e.g., 401(k), 403(b) or 457(b) plans), traditional IRAs, and individual retirement annuities are subject to required minimum distribution rules, which require benefits to be distributed or commence being distributed by the required beginning date (RBD).

Under pre-Act law, the RBD for IRAs is April 1 following the calendar year in which the IRA owner attains age 70-1/2. For employer-sponsored retirement plans, for non-5% company owners, the RBD is April 1 following the later of the calendar year in which the employee attains age 70-1/2 or retires. For an employee who is a 5% owner, the RBD is the same as for IRAs even if the employee continues to work past age 70-1/2. 

A number of payout choices are available where an IRA or retirement plan account owner dies before the RBD and the spouse is the account’s beneficiary. Under pre-Act law, one of these choices allows the spouse to delay distributions from the decedent’s account until Dec. 31 of the year in which the decedent would have attained age 70-1/2. 

New law. Under the SECURE Act, the RBD for IRAs is April 1 following the calendar year in which the IRA owner attains age 72. For employer-sponsored retirement plans, for non-5% company owners, the RBD is April 1 following the later of the calendar year in which the employee attains age 72 or retires. For an employee who is a 5% owner, the RBD is the same as for IRAs even if the employee continues to work past age 72.

In a conforming change, where an IRA or retirement plan account owner dies before the RBD and the spouse is the account’s beneficiary, the spouse will be able to delay distributions from the decedent’s account until Dec. 31 of the year in which the decedent would have attained age 72.

Effective date: The above required-beginning-date changes are effective for distributions required to be made after Dec. 31, 2019, with respect to individuals who attain age 70-1/2 after that date. 

 

Expansion of Section 529 Plans

Under Code Sec. 529 , a State or its agency or instrumentality may establish or maintain a program that allows a person to prepay or contribute to an account for a designated beneficiary’s qualified higher education expenses. In addition, an eligible educational institution may establish or maintain a program that allows a person to prepay a designated beneficiary’s qualified higher education expenses. These programs are collectively referred to as 529 plans. Code Sec. 529 provides that distributions (including any attributable earnings) from a 529 plan are not included in gross income if such distributions do not exceed the designated beneficiary’s qualified higher education expenses.

Under pre-Act law, higher education expenses meant tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a designated beneficiary at an eligible educational institution, and expenses for special needs services in the case of a special needs beneficiary that are incurred in connection with such enrollment or attendance. Qualified higher education expenses generally also include room and board for students who are enrolled at least half-time. Qualified higher education expenses include the purchase of any computer technology or equipment, or Internet access or related services, if such technology or services are to be used primarily by the beneficiary during any of the years a beneficiary is enrolled at an eligible institution.

For distributions made after Dec. 31, 2017, a designated beneficiary may receive up to $10,000 in aggregate 529 distributions on an annual basis for expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school. To the extent such distributions do not exceed $10,000, they are treated in the same manner as distributions for qualified higher education expenses.

Certain individuals who have paid interest on qualified education loans may claim an above-the-line deduction for such interest expenses, subject to a maximum annual deduction limit of $2,500 with the deduction is phased out ratably (for 2019 the phaseout applies to taxpayers with modified AGI between $70,000 and $85,000 ($140,000 and $170,000 for married taxpayers filing a joint return).

New law. For distributions made after Dec. 31, 2018, the SECURE Act expands Code Sec. 529 education savings accounts to cover costs associated with registered apprenticeships and up to $10,000 of qualified student loan repayments (principal or interest). A special rule for qualified student loan repayments allows such amounts to be distributed to a sibling of a designated beneficiary (i.e., a brother, sister, stepbrother, or stepsister).

The deduction for interest paid by the taxpayer during the tax year on a qualified education loan is disallowed to the extent the interest was paid from a tax-free distribution from a 529 plan.

 

EXPANDING AND PRESERVING RETIREMENT SAVINGS

Difficulty-of-Care Payments Treated as Compensation for Retirement Contribution Limits

A foster care provider doesn’t include in gross income qualified foster care payments. Qualified foster care payments include any payment made pursuant to a foster care program of a State or political subdivision which is paid by (1) a State or political subdivision thereof or (2) a qualified foster care placement agency, and which is either (a) paid to the foster care provider for caring for a qualified foster individual in the foster care provider’s home, or (b) a ”difficulty of care” payment.” A ”difficulty of care” payment is compensation for providing the additional care needed for certain qualified foster individuals. Such payments are provided when a qualified foster individual has a physical, mental or emotional disability for which the State has determined that (1) there is a need for additional compensation to care for the individual, (2) the care is provided in the home of the foster care provider, and (3) the payments are designated by the payor as compensation for such purpose.

Since ”difficulty of care” payments are excluded from gross income, home healthcare workers receiving only such payments are unable to participate in tax-qualified retirement plans or individual retirement accounts because ”difficulty of care” payments are not considered compensation or earnings upon which contributions to such plans or accounts may be made.

New law. For defined contribution plan years beginning after Dec. 31, 2015 and for IRA contributions after the enactment date (Dec. 20, 2019), the SECURE Act provides that for home healthcare workers, “difficulty of care” payments are treated as compensation for purposes of calculating the contribution limits to defined contribution plans and IRAs.

 

REVENUE PROVISIONS

Post-Death Required Minimum Distribution Rules Modified

Minimum distribution rules apply to tax-favored employer-sponsored retirement plans and IRAs. While an employee (or IRA owner) is alive, distributions of the individual’s interest are required to be over the life or life expectancy of the employee (or IRA owner), or over the joint lives or joint life expectancy of the employee (or IRA owner) and a designated beneficiary.

Under pre-Act law, the after-death minimum distributions rules vary depending on (a) whether an employee (or IRA owner) dies before, on, or after the required beginning date, and (b) whether there is a designated beneficiary for the benefit. Under the regs, a designated beneficiary generally must be an individual. If an employee (or IRA owner) dies on or after the required beginning date, the basic statutory rule is that the remaining interest must be distributed at least as rapidly as under the method of distribution being used before death.

If an employee (or IRA owner) dies before the required beginning date and any portion of the benefit is payable to a designated beneficiary, the statutory rule is that distributions are generally required to begin within one year of the employee’s (or IRA owner’s) death and are allowed to be paid over the life or life expectancy of the designated beneficiary. If the beneficiary of the employee (or IRA owner) is the individual’s surviving spouse, distributions are not required to begin until the year in which the employee (or IRA owner) would have attained age 70½. If the surviving spouse dies before the employee (or IRA owner) would have attained age 70½, the after-death rules apply after the death of the spouse as though the spouse were the employee (or IRA owner).

If an employee (or IRA owner) dies before the required beginning date and there is no designated beneficiary, then the entire remaining interest of the employee (or IRA owner) must generally be distributed by the end of the fifth calendar year following the individual’s death (the 5-year rule).

New law. Generally effective for distributions with respect to employees (or IRA owners) who die after Dec. 31, 2019 (see below for exceptions), the SECURE Act modifies the required minimum distribution rules with respect to defined contribution plan and IRA balances (including annuity contracts purchased from insurance companies under defined contribution plans or IRAs) upon the death of the account owner. 

Under the SECURE Act, the general rule is that after an employee (or IRA owner) dies, the remaining account balance must be distributed to designated beneficiaries within 10 years after the date of death. This rule applies regardless of whether the employee (or IRA owner) dies before, on, or after the required beginning date, unless the designated beneficiary is an eligible designated beneficiary (see below). The Code explains that under the 10-year rule, the remaining account balance must be distributed by the end of the tenth calendar year following the year of the employee or IRA owner’s death.

Observation. In general, for distributions required to be made after Dec. 31, 2019, with respect to individuals who attain age 70-1/2 after that date, SECURE Act Sec. 114 defers the required beginning date for lifetime distributions to April 1 following the calendar year in which the employee (or IRA owner) attains age 72 (instead of age 70-1/2 under pre-SECURE Act law). 

An exception to the 10-year rule for post-death required minimum distributions applies to an eligible designated beneficiary. This is an individual who, with respect to the employee or IRA owner, on the date of his or her death, is:

(1) the surviving spouse of the employee or IRA owner;

(2) a child of the employee or IRA owner who has not reached majority;

(3) a chronically ill individual as specially defined in Code Sec. 401 , and

(4) any other individual who is not more than ten years younger than the employee or IRA owner.

Under the exception, following the death of the employee or IRA owner, the remaining account balance generally may be distributed (similar to pre-Act law) over the life or life expectancy of the eligible designated beneficiary, beginning in the year following the year of death. 

Following the death of an eligible designated beneficiary, the account balance must be distributed within 10 years after the death of the eligible designated beneficiary. After a child of the employee or IRA owner reaches the age of majority, the balance in the account must be distributed within 10 years after that date.

For governmental plans, the changes apply to distributions with respect to employees who die after Dec. 31, 2021.

Additionally, the modification to the after-death minimum distribution rules does not apply to a qualified annuity that is a binding annuity contract in effect on the date of enactment (Dec. 20, 2019) and at all times thereafter.

10-year rule following death of beneficiary where account owner dies before effective date. A special rule applies in the case of an employee (or IRA owner) who dies before the “effective date” (see below) for the plan (or IRA), and the designated beneficiary of the employee (or IRA owner) dies on or after the “effective date.” In this situation:

(A) the required distribution rules carried in SECURE Act apply to any beneficiary of the designated beneficiary chosen by the employee or IRA owner, and

(B) the designated beneficiary chosen by the employee or IRA owner will be treated as an eligible designated beneficiary. 

For purposes of this special rule, the “effective date” here is the date of death of the employee (or IRA owner) used to determine when the provision applies to the plan (or IRA), for example, before January 1, 2020, under the general effective date. 

Illustration (1).   Anne dies in 2020 and leaves her IRA to designated beneficiary Ben, her brother, who was born eight years after Anne. Ben is an eligible designated beneficiary, and the balance in the IRA at Anne’s death may be paid over Ben’s life or life expectancy. If Ben dies before the IRA account is exhausted, the remaining balance must be paid out within 10 years after Ben’s death.

Illustration (2).  Chad dies in 2020 and leaves his IRA to designated beneficiary Dee, his sister who was born 12 years after Chad. Dee is not an eligible designated beneficiary because she is more than 10 years younger than Chad, and the balance in the IRA at Chad’s death must be paid out within 10 years after Chad’s death.

Illustration (3).   Jack dies on Nov. 30, 2019, and leaves his IRA to designated beneficiary Frank, his nephew, who is 30 years younger than Jack. Because Jack died before 2020, Frank is treated as an eligible designated beneficiary (even though the age disparity between the two is greater than 10 years) and the balance in the IRA at Jack’s death may be paid over Frank’s life or life expectancy. If Frank dies on or after Jan. 1, 2020, before the balance in the IRA is exhausted, the account balance must be paid out to any beneficiary of Frank within 10 years after Frank’s death. 

The above listed provisions of the SECURE Act are only a sample of the entire Act. This summary is meant as a guide in helping you plan your investment strategy for your eventual retirement. Feel free to contact our office to discuss your specific circumstances with one our Certified Financial Planners and/or tax consultants.