Regulation & Legislation
10 MIN ARTICLE
Q: The SECURE Act consists of many provisions, but broadly, what were the main themes?
A: From a retirement plan perspective, there are two centerpieces of the legislation. First, Congress wanted to expand retirement plan coverage for small businesses. Currently, only 40% of small businesses offer retirement plans, so Congress wants to fill that gap. The second goal was to get participants to start thinking about retirement plans as vehicles for retirement income, and not just as savings vehicles.
Q: What did the Act do to address the first problem — a lack of coverage among small businesses?
A: The Act enhanced the startup plan tax credit to expand coverage and created a new auto-enrollment tax credit to improve plan design. For some time, small businesses starting their first-ever retirement plan have received a federal tax credit to offset 50% of the expenses the employer paid in connection with a startup plan. The tax credit can be used for up to three years after the plan’s launch. The Act significantly increased that tax credit from a maximum of $500 a year to up to $5,000 a year. Again, this is only for a small plan sponsor that has not maintained any retirement plan, including a Savings Incentive Match Plan for Employees (SIMPLE) or a simplified employee pension (SEP) plan, in recent years. The second credit is for a small plan that, for the first time, adds an auto-enrollment feature. And that credit is a flat $500 annually for up to three years. The idea is that the credit will offset some or all of the additional employer cost from higher matching contribution rates, but it applies to plans that do not have a match as well. Both tax credit changes apply to taxable years beginning after December 31, 2019.
Q: How impactful are those two credits for small-business owners and their employees?
A: The startup tax credit should be very attractive to small businesses. It will be a great talking point for retirement plan advisors whose clients are on the fence about starting a plan. The auto-enrollment credit could also be a big deal. Auto-enrollment has clearly been effective at getting people to start saving, but it is much less common as a plan feature in the small-employer market. If both those tax credits take off, we could see a significant boost in plan participation and savings adequacy. These are incremental but significant steps in encouraging small businesses to offer retirement savings to their employees.
KEY PROVISIONS OF THE SECURE ACT
Source: Capital Group
Q: Are there any details of the tax credits that retirement plan advisors and plan sponsors should be aware of?
A: The startup tax credit only covers the employer’s out-of-pocket costs. It doesn’t apply to expenses paid through plan assets, such as 12b-1 fees. Also, not every plan sponsor will receive the maximum $5,000 credit. There is a formula that limits the maximum to $250 multiplied by the number of non-highly compensated employees who are eligible to participate in the plan. Note that the limit is based on the number of employees who are eligible, not who are in fact participating.
Q: How does the Act help part-time workers?
A: It helps a bit. Congress has been slowly finding its way on how to address the needs of the contingent workforce, which has become a significant part of the U.S. labor market and is expected to grow. These include people who don’t work full time for a corporation, and indeed may even be perpetual part-time employees juggling multiple jobs. So, the Act says that if an employee has completed at least 500 hours of service each year for three consecutive years, the plan sponsor must let him or her into the plan — but only for elective deferral purposes. These long-term, part-time employees don’t have to be considered in any nondiscrimination testing. So those employees must be allowed in the plan, but they aren’t entitled to receive any matching or nonelective contributions. By excluding any requirements for nondiscrimination testing, the regulation is helpful but not onerous on employers. These changes will apply to plan years beginning after December 31, 2020.
Q: How will the change for part-time workers impact plan sponsors?
A: It’s possible that, with the addition of the part-time employees, smaller plans may end up growing to 100 participants or more. That number triggers the requirement that a plan sponsor hire an outside accountant to annually audit the plan’s financial statements.
Q: Besides tax credits, how does the Act seek to promote small-business coverage?
A: A major change was to so-called multiple-employer plans (MEPs). The Act removed some barriers that had prevented unrelated small businesses from joining into one plan under the Employee Retirement Income Security Act (ERISA). The Act allows these “open” MEPs to be sponsored by a financial institution, such as a recordkeeper, broker-dealer or third-party administrator. These changes take effect for plan years beginning after December 31, 2020.
Q: What’s the potential appeal of an MEP to small businesses?
A: The hope is that, by pooling their assets into one plan, small businesses can lower their costs by achieving economies of scale. Also, the MEP sponsor would be the named fiduciary in the plan as well as the plan administrator. This would allow the plan sponsors to transfer some — but certainly not all — of their fiduciary responsibilities to the institution, although plans can basically do the same today through 3(38) fiduciary services and 3(16) administrative services.
Q: Are there any concerns about MEPs?
A: I think it’s unclear whether the cost savings will be significant. For instance, recordkeeping costs tend to be more tied to the number of accounts and the number of transactions than they are to the size of plan assets. And many of the existing MEPs — so-called “closed” MEPs — have not been able to produce cost savings. And there are some hurdles and questions around how open MEPs will operate. A major outstanding issue is how the MEPs will handle governance and potential conflicts of interest. For instance, what protective conditions will apply if the financial institution sponsoring the MEP places its own mutual funds into the MEP’s investment menu? Can it hire itself as a recordkeeper? Given these issues, I would not be surprised to see the Department of Labor issue its own guidance on these issues down the road.
Q: How does the Act seek to transition retirement accounts from savings vehicles to partial sources of lifetime income? Is it possible for 401(k) plans to serve that role?
A: The biggest change is a modification of the existing fiduciary “safe harbor” for annuities offered in a retirement plan. Despite this safe harbor, many plan sponsors have been reluctant to offer in-plan annuity options. There are a number of barriers to lifetime income options in defined contribution plans, but one worry has been, “What happens if the insurance company becomes insolvent many years down the road?” The previous safe harbor required plan sponsors to investigate the claims-paying ability of the insurer. That kind of investigation is a daunting exercise for a plan sponsor. This law says that plan sponsors essentially can rely on state insurance commissioners to police for solvency. If the insurer can give the sponsor some representation that it is in good standing with state regulators, a fiduciary can rely on that and get the safe harbor. So that reduces a major barrier to the use of lifetime income products in plans. This change is effective with plan years beginning after December 31, 2019.
Q: Were there other provisions to encourage in-plan annuities?
A: Yes. Another provision dealt with what I like to call the Amazon rule. The entire goal of Amazon’s return policy is to make it easy for you to return a product you’ve bought, so you’ll be more likely to buy in the future. But it has been the exact opposite for annuities. Prior to the Act, it was very difficult for a plan sponsor to get rid of an in-plan annuity. If the plan sponsor were to liquidate it, participants who had been using or who had paid into it would lose any economic benefit they had purchased. The Act addresses that. If an annuity is eliminated from a plan, participants can take a distribution of the lifetime income investment without regard to any of the in-service withdrawal restrictions. That provision is in effect now. All that said, the hurdles to adoption of annuities in a plan remain high. Furthermore, annuities are viewed as expensive, and many of them are. It will be interesting to see if the Act in fact prompts plan sponsors to include annuities in 401(k) plans.
Q: How does the Act encourage participants to think more about retirement income?
A: The Act requires that at least one benefit statement annually should have a “lifetime income equivalent.” Basically, the statement must illustrate how much in future monthly income a participant might generate from an account balance. Today, it’s hard for participants to translate the lump sum they see in their statements — say, $200,000 — into decades of monthly retirement income. That’s why many recordkeepers already offer lifetime income estimates on their websites. The point of this provision is to get people to think about their account balance more in terms of a retirement paycheck, not just as a lump sum.
Q: When will that provision take effect?
A: It will take effect 12 months after the Department of Labor releases guidance on just how to produce the monthly estimate. And it’s not an easy task. For example, should you assume future employee contributions? If you don’t assume future contributions, the monthly income estimate may be so low for younger participants that some might say, “This is hopeless,” and give up. And there are other issues. What rate of return should you use? What’s the inflation assumption? I think this might take some time for the Department to figure out.
Q: How soon will plan sponsors have to address these changes in their plan documents?
A: Certainly not right away. Generally, new laws include remedial amendment periods — often several years. So there’s no urgency on updating documents. However, plan sponsors should start thinking about how to communicate some of the Act’s changes. For example, the Act permits penalty-free withdrawals of up to $5,000 for expenses related to the birth or adoption of a child for up to one year following the birth or legal adoption. That went into effect at the start of 2020, so plan sponsors may want to communicate that benefit to their employees.