The Consolidated Appropriations Act, 2023 (CAA 2023), signed into law on December 29, 2022, includes the long-debated and expected changes to employer-sponsored benefit programs under Division T of the law, the SECURE 2.0 Act of 2022.
There are over 90 provisions addressed in the new law, and this article is one in a series by Milliman that looks for any harmonizing themes among the provisions.
Other articles in this series examine some of the other types of changes to the law impacting Americans’ ability to save and access their retirement funds. This article focuses on five provisions related to both mandatory and voluntary changes to employee and employer contributions applicable to defined contribution (DC) plans.
The provisions impacting contributions are some of the hottest topics in SECURE 2.0 and are among those with the most questions surrounding them. Clarification from the Internal Revenue Service (IRS) on actual operations, limits, and procedures will be crucial, and should be considered before making any decisions on adopting or implementing these provisions.
The list below provides a brief description of each provision and indicates whether it is mandatory or voluntary.
Effective retroactive to December 29, 2022
Section 101 (mandatory) requires that all Internal Revenue Code (IRC) 401(k) and 403(b) plans established after the enactment date (December 29, 2022) to include an eligible automatic contribution arrangement (EACA) beginning with plan years after December 31, 2024. Plans must have an automatic deferral rate of at least 3% up to 10% and an automatic escalation of 1% a year up to a maximum deferral rate between 10% and 15%.
This rule also applies to an employer that begins participating in a multiple-employer plan (MEP) after the enactment date, even if the MEP was established before December 29, 2022. Savings Incentive Match Plan for Employees (SIMPLE) plans, governmental plans, church plans, businesses in existence for less than three years, and small businesses with fewer than 10 employees are exempt from this requirement.
Observation: Care should be given to establishing proper procedures between the plan sponsor and its administrators to ensure proper operation of the automatic enrollment features to avoid any missed deferral corrections.
Section 604 (voluntary) enables plans to allow employees to designate employer matching or nonelective contributions as Roth at the time they are made to the plan. The amounts are immediately includable in an employee’s income. The amounts must be 100% vested at the time of deposit to the plan. This can additionally apply to student loan matching contributions discussed below.
Observation: This option may be appealing to many employees. However, those electing this treatment will need to ensure they are prepared to pay the income tax on these employer contributions annually. There may be some sticker shock if not properly communicated to employees.
Effective in 2024
Section 110 (voluntary) allows for employer contributions made on “qualified student loan payments” to be treated as matching contributions by treating the student loan payment as a participant deferral under the 401(m) regulations. Employers may rely on an employee self-reporting and certification of payment. The actual deferral percentage (ADP) test may be applied separately to all employees receiving the match due to student loan payments.
Observation: This change is a welcome addition for plan sponsors looking for additional ways to assist employees in saving for retirement and paying down student loan debt. Plan sponsors and administrators will need to determine best practices regarding engaging a vendor to qualify the student loan payments or allowing employee self-certification.
Section 603 (mandatory) requires catch-up contributions made by eligible participants in 401(k), 403(b), or governmental 457(b) plans that allow such contributions, who made over $145,000 in the prior year as indexed for inflation, to be made on a Roth basis.
Observation: Plans that offer catch-up contributions but don’t currently allow Roth contributions will have to be amended for this mandatory provision. Payroll systems will have to be modified to accommodate this change as well. Participants may not want to make Roth contributions, which could stop their catch-up contributions altogether. Participant education will be needed to explain how Roth contributions work.
Effective in 2025
Section 109 (voluntary) increases the catch-up contribution limit specific to participants age 60 but less than age 64 to the greater of $10,000 or 150% of the regular catch-up limit, as indexed for inflation. The simple plan catch-up limit increase is the greater of $5,000 or 150% of the regular limit.
Observation: The effective date is a year later than that of Section 603, but the Roth nature of the contributions holds true. If a participant earns more than $145,000 (an annually indexed amount) in the prior calendar year, these catch-up contributions must be Roth contributions, not pretax contributions. If the compensation is less than the indexed amount, then catch-up contributions may be either pretax or Roth.
The increased limits are great for participants who can afford to contribute additional amounts but the parameters surrounding the provision could reduce catch-up contributions if participants don’t want to make Roth contributions. Employers may also face administrative and communication challenges due to the new limits.
While many of these changes sound quite simple and straightforward, implementing them presents many challenges to plan sponsors and recordkeepers, a few of which are described below.
Significant system updates
All of these changes will require significant recordkeeping and payroll system updates.
- Employers that begin participating in a multiple-employer 401(k) or 403(b) plan will have to include an EACA for participants of any new employer, adding to the complexity of tracking these individuals.
- Adding a Roth element to employer matching, nonelective contributions, or student loan payment provisions creates additional sources that must be individually tracked in payroll and recordkeeping systems.
- Additional monitoring and communication will be essential as participants move through the increased catch-up limits (particularly at ages 60 and 64 when the new limits start and stop), or when catch-up contributions must be made as Roth.
- The $145,000 pay threshold for catch-up contributions is based on total compensation rather than plan compensation. This will require a new compensation field to be added to systems to properly track which plan participants are impacted by it.
Roth catch-up contribution complexity
It is unclear exactly how the Roth catch-up requirement will impact elective deferral amounts. For example, will participants be able to reclassify contributions as catch-up to avoid a refund when meeting a plan-imposed or regulatory limit or in the event of a failed ADP test? Such reclassification would be done through an in-plan conversion to Roth. However, more guidance is needed to be certain whether such conversions are allowed and what amendment will be required to the plan document, if any. We do know that plans that do not currently include a Roth provision will either need to add it or will not be allowed to offer catch-up contributions to highly paid participants after December 31, 2023.
Participant communication and elections
Enabling employees to designate their employer contributions as Roth is another area where extensive guidance is needed. Essentially this provision creates an in-plan Roth conversion at each employer contribution deposit period, be that annual, quarterly, or with each payroll. The complexities around communication of a participant’s elections and coordination with payroll, taxation, and recordkeeping systems could cause significant challenges. One of the key requirements is that the match must be fully vested at the time of deposit, so that may allow for flexibility in how the provisions are applied.
Inadvertent elimination of catch-up contributions
We note that SECURE 2.0 inadvertently removed language that would allow catch-up contributions for anyone. It is expected that this will be fixed in a technical correction prior to 2024.
Guidance is needed before implementation
As we have mentioned in previous articles, it is unclear when formal guidance will be released. It is possible that the IRS and the U.S. Department of Labor (DOL) will not enforce any penalties on early adoption and instead will permit any technical changes to be made after formal guidance is released. We can assume there will be “good faith compliance” in that vacuum of formal guidance.
These provisions are some of the most discussed by plan sponsors, recordkeepers, administrators, and payroll providers. All of the plan’s professionals will need to work very closely to coordinate the provisions and ensure compliance once guidance is issued. The guidance on these provisions will be extremely important.
Please contact your Milliman consultant for how these provisions may impact your DC program.