IRS issues grab bag guidance on SECURE 2.0

On December 20, 2023, the Internal Revenue Service (IRS) issued Notice 2024-2, guidance to help plan sponsors implement certain provisions of the SECURE 2.0 Act of 2022 (SECURE 2.0). The guidance is not intended to be comprehensive, and the U.S. Department of Treasury and IRS anticipate issuing more guidance as they continue to analyze the new law.

In this Client Action Bulletin, we focus on seven provisions in the notice affecting employer-sponsored defined benefit (DB) and defined contribution (DC) plans.

• Expanding automatic enrollment in DC plans
• Small immediate financial incentives for contributing to a plan
• Safe harbor for correction of employee elective deferral failures
• Optional treatment of employer contributions or nonelective contributions as Roth contributions
• Early distributions from qualified plans for terminal illness
• Interest crediting rate for cash balance plans
• Plan amendment deadlines

Expanding automatic enrollment in DC plans

Section 101 of SECURE 2.0 requires all 401(k) qualified cash or deferred arrangements (CODAs) and 403(b) plans established after December 29, 2022, the SECURE 2.0 enactment date, to include an eligible automatic contribution arrangement (EACA) beginning with plan years after December 31, 2024, unless an exception applies. These mandatory automatic enrollment requirements also apply to employers adopting a plan maintained by more than one employer¹ after December 29, 2022.

Pre-enactment 401(k) qualified CODAs and 403(b) plans are plans established before December 29, 2022. They are exempt from these mandatory automatic enrollment requirements. Also exempt are governmental plans, church plans, and plans maintained by certain new businesses and small businesses.

Notice 2024-2 concentrates on when a qualified CODA is established and how mergers and spinoffs impact whether the automatic enrollment rules apply.

When a CODA is established

For purposes of Section 101, a 401(k) qualified CODA is established on the date plan terms providing for the CODA are adopted initially, even if the effective date is after the adoption date.

• Example: new 401(k) plan. An employer adopted a new 401(k) plan on October 3, 2022, with an effective date of January 1, 2023. In this instance, the qualified CODA is considered established on October 3, 2022, and would therefore be a pre-enactment CODA exempt from the automatic enrollment requirements.
• Example: existing profit-sharing-only plan adds 401(k) salary deferral arrangement. An employer adopted a plan amendment to its existing profit-sharing plan on October 3, 2022, to add a 401(k) salary deferral arrangement with an effective date of January 1, 2023. In this instance, the qualified CODA is considered established on October 3, 2022, and would therefore be a pre-enactment CODA exempt from the automatic enrollment requirements.

For 403(b) plans, in contrast, establishment is determined without regard to the date of adoption of plan terms that provide for salary reduction agreements. In other words, the original adoption date of the 403(b) plan applies, even if a plan amendment is adopted at a later date to initially provide for elective deferrals under a salary reduction agreement.

Merger of two plans with pre-enactment qualified CODAs

If a single-employer plan with a pre-enactment qualified CODA merges with another plan that includes a pre-enactment qualified CODA (either another single-employer plan or a plan maintained by more than one employer), then the qualified CODA in the ongoing plan after the merger is treated as a pre-enactment qualified CODA and is not subject to the automatic enrollment requirements.

Merger between two plans where only one includes a pre-enactment qualified CODA

If a single-employer plan with a qualified CODA that is not a pre-enactment qualified CODA merges with another single-employer plan that includes a pre-enactment qualified CODA, then the qualified CODA in the ongoing plan is generally not treated as a pre-enactment qualified CODA after the merger.

However, if the above merger is connected to a change in controlled group or related group of employers, such as an acquisition, and the plan that includes the pre-enactment qualified CODA is designated as the ongoing plan, then the qualified CODA in the ongoing plan after the merger is treated as a pre-enactment qualified CODA only if the plan merger occurs by the last day of the first plan year beginning after the change in the controlled group or related group of employers (the Internal Revenue Code (IRC) Section 410(b)(6)(C) transition period).

If a single-employer plan with a qualified CODA that is not a pre-enactment qualified CODA merges into a plan maintained by more than one employer that includes a pre-enactment qualified CODA, then the qualified CODA in the ongoing plan is not treated as a pre-enactment qualified CODA after the merger for the new participating employer but would remain a pre-enactment qualified CODA for the remaining employers in the ongoing plan.

Spinoffs

In general, if a new plan were spun off from a single-employer plan that included a pre-enactment qualified CODA, then the qualified CODA in the new spun-off plan would be treated as a pre-enactment qualified CODA.

However, if the new plan was spun off from a plan maintained by more than one employer established before December 29, 2022, then the qualified CODA in the new spun-off plan would be treated as a pre-enactment qualified CODA only if the qualified CODA in the plan maintained by more than one employer was treated as a pre-enactment qualified CODA with respect to the employer sponsoring the spun-off plan.

Starter 401(k) and 403(b) plans

Starter 401(k) and 403(b) deferral-only plans, new types of plans added by SECURE 2.0 for plan years beginning in 2024, are subject to the mandatory automatic enrollment requirements (unless an exception applies, such as the exception for plans maintained by new and small businesses).

Small immediate financial incentives for contributing to a plan

Section 113 of SECURE 2.0 allows sponsors of 401(k) and 403(b) plans to provide de minimis financial incentives (such as gift cards in small amounts) not paid for with plan assets to employees to encourage them to participate in the plan, without violating the IRC “contingent benefit rule” that otherwise prohibits employer-provided benefits (except matching contributions) that are conditioned on the employee making elective deferral contributions to the plan. De minimis financial incentives are exempt from the IRS excise tax on prohibited transactions and from the ERISA prohibited transaction rules. This provision applies to plan years beginning after December 29, 2022. Notice 2024-2 provides the following guidelines:

De minimis amount

A de minimis financial incentive may not exceed $250 in value.

Recipients of the incentive

A de minimis financial incentive may only be offered to employees for whom no election to defer under the CODA is already in effect. The incentive could be provided one-time or as installments (not to exceed $250 in total value) that are contingent on the employee’s continuing to make elective deferral contributions to the plan.

• Example: An employer announces on February 1, 2024, that any employee who has not yet elected to defer under a CODA as of that date will receive a $200 gift card if they make an election to defer within the next 90 days.
• Example: The employer from the previous example could instead provide a $100 gift card after the initial election to defer with a promise to provide an additional $100 gift card a year later if the employee has continued to defer until that later date.

Matching contributions

A matching contribution cannot be a de minimis financial incentive.

Not a plan contribution

A de minimis financial incentive is not subject to the IRC rules that apply to a plan contribution, including qualification requirements and deductibility timing rules.

Incentive is considered wages

A de minimis financial incentive generally must be included in the employee’s gross income and wages and is subject to applicable withholding and reporting requirements for employment tax purposes (unless an exception applies). For example, a gift card, as a cash equivalent, is a taxable fringe benefit that is taxable as wages.

Safe harbor for correction of employee elective deferral failures

Section 350 of SECURE 2.0 provides that a 401(k), 403(b), or governmental 457(b) plan will not lose their qualified plan status solely because of a corrected error. A corrected error is a reasonable administrative error made in implementing an automatic enrollment or automatic escalation feature for an eligible employee, or a failure to provide an eligible employee the opportunity to make an affirmative salary deferral election because the employee was improperly excluded from the plan. Notice 2024-2 calls these corrected errors implementation errors and provides the following guidance:

When corrections must be made

Implementation errors with respect to elective deferrals must be corrected by the earlier of:

1. The date of the first payment of compensation to the employee on or after the last day of the 9½-month period after the end of the plan year during which the error first occurred.
2. In the case of an employee who notifies the plan sponsor of the error, the date of the first payment of compensation to the employee on or after the last day of the month following the month in which the notification was made.

The effective date of this provision may vary based on factors like the date of error, date when compensation is paid, whether the employee notifies the plan sponsor of the error, and whether the plan year is a fiscal year or calendar year. If this date is after December 31, 2023, correction under Section 350 applies.

• Example: An employer sponsors a calendar year 401(k) plan that has an automatic contribution enrollment feature. The employer fails to automatically enroll an eligible employee on January 1, 2023, due to an implementation error. The employee does not inform the employer of the error.
  
  October 15, 2024, is 9½ months following the end of the plan year of the error, and the first payroll payment after that date is October 18, 2024. The employer has until October 18, 2024, to begin corrected elective deferrals for the affected eligible employee. Because October 18, 2024, is after December 31, 2023, correction under Section 350 applies to the error.

Implementation errors

A plan sponsor can correct an implementation error with respect to active and terminated employees by following the safe harbor correction method in Appendix A, Section .05(8), of Rev. Proc. 2021-30, the current version of the IRS Employee Plans Correction Resolution System (EPCRS), for failures related to automatic contribution features in a 401(k) or 403(b) plan, with a modified notice to terminated employees.

Matching contributions

If an employee affected by an implementation error would have been entitled to matching contributions had missed elective deferrals been made, a corrective allocation of matching contributions (adjusted for earnings) must be made within a reasonable period after the date the correct elective deferrals begin (or would have begun in the case of a terminated employee). A period is considered reasonable if the allocation is made by the last day of the sixth month following the month in which correct elective deferrals begin. For an automatic contribution error that begins on or before December 31, 2023, a corrective allocation of matching contributions made by the end of the third plan year following the year in which the error occurred is considered reasonable.

Optional treatment of employer contributions or nonelective contributions as Roth contributions

Section 604 enables plans to allow employees who are 100% vested to designate employer matching or nonelective contributions as Roth contributions, even if the plan does not permit Roth elective deferral contributions. The designated Roth employer contribution amounts are includible in an employee’s income for the taxable year in which they are allocated.

Contribution rules

Rules like those for designated Roth elective deferral contributions apply to designated Roth employer matching and nonelective contributions, with certain exceptions. Employees must designate these contributions as Roth contributions no later than when they are allocated to their accounts, and this designation is irrevocable. If the plan permits employees to designate employer matching contributions or nonelective contributions as Roth contributions, then the employee must have the opportunity to make or change that designation at least once during each plan year.

Taxable year

Designated Roth matching or nonelective contributions are included in an individual's gross income for the taxable year in which the contribution is allocated to their account. This is the case even if the designated Roth matching or nonelective contribution is deemed to have been made on the last day of the employer’s prior taxable year.

Fully vested requirement

An employee can only designate a matching or nonelective contribution as a Roth contribution if they are fully vested in that type of contribution at the time it is allocated to their account. If the employee is only partially vested in that type of contribution when it is allocated to their account, they may not designate any part of the contribution as a Roth contribution.

Nondiscrimination requirements

A plan will not fail to satisfy nondiscrimination requirements just because it provides that an employee may designate an employer matching or nonelective contribution as a Roth contribution only if they are fully vested in that type of contribution at the time it is allocated to their account.

Wages

Designated Roth matching and nonelective contributions are not included in wages for federal income tax withholding purposes.

• Designated Roth matching and nonelective contributions to a qualified plan (including a 401(k) plan) or 403(b) plan, are not included in wages for purposes of the Federal Insurance Contributions Act (FICA) or the Federal Unemployment Tax Act (FUTA).
• Because designated Roth nonelective contributions to a governmental 457(b) plan must be fully vested at the time they are allocated to a participant’s account, they are subject to Social Security and Medicare taxes at that time, but only for employees of state or local governmental entities that are covered by Social Security and Medicare (for example, under a voluntary Social Security Act Section 218 agreement with the Social Security Administration or if the employees are not covered under a state or local governmental retirement plan or system).
• Designated Roth nonelective contributions to a governmental 457(b) plan are excluded from wages for purposes of FUTA.

Reporting obligations

Designated Roth matching and nonelective contributions are treated as in-plan Roth rollovers and must be reported using Form 1099-R for the year in which the contributions are allocated to the individual's account.

IRC Section 415 safe harbor definition of compensation

If a plan uses a Section 415 safe harbor compensation definition, designated Roth matching and nonelective contributions are not included in that safe harbor definition of compensation.

Roth contribution types

A plan that includes a qualified Roth contribution program may include any type of designated Roth contribution but is not required to include all types. Therefore, a plan may permit an employee to designate an elective deferral contribution as Roth without being permitted to designate an employer matching or nonelective contribution as Roth, and vice versa. This means a plan may permit employees to designate a matching contribution or nonelective contribution as a Roth contribution, even if the plan does not permit Roth elective deferral contributions.

Early distributions from qualified plans for terminal illness

Section 326 of SECURE 2.0 provides an exception to the 10% penalty tax for an early distribution made from a qualified retirement plan to an employee who, prior to receiving the distribution, is certified by a physician as having a terminal illness (i.e., terminally ill individual distribution). This provision is discretionary and applies to terminally ill individual distributions made after December 29, 2022. Guidance from Notice 2024-2 is summarized below.

Qualified retirement plan

Plans that may permit terminally ill individual distributions are qualified retirement plans (including defined benefit and defined contribution plans such as profit-sharing plans and 401(k) plans), and 403(b) plans, but not governmental 457(b) plans. Plan amendments to permit terminally ill individual distributions are discretionary amendments. The deadline for adopting plan amendments related to SECURE 2.0 is discussed below.

Physician’s certification

An employee must furnish to the plan administrator a physician’s certification that certifies that the employee is a terminally ill individual. The physician’s certification alone is sufficient evidence. The supporting documentation upon which the certification is based does not need to be provided to the plan administrator. However, the employee should retain both the supporting documentation and a copy of the physician’s certification for their tax records.

The certification must include a statement that the individual’s illness or physical condition can be reasonably expected to result in death in 84 months or less after the date of certification, a narrative description of the supporting evidence, the name and contact information of the physician, the date the physician examined the individual, the signature of the physician, and the date signed. Employee self-certifications are not acceptable.

A physician generally means a doctor of medicine or osteopathy that is legally authorized to practice medicine and surgery by the state in which the doctor performs such function or action.

Terminally ill individual distribution and optional repayment

The terminally ill individual distribution must be made on or after the physician’s certification date. A plan’s distribution restriction requirements (e.g., age 59½ in-service withdrawal, hardship, disability) continue to apply. Therefore, the employee receiving the terminal illness distribution must otherwise be eligible for a permissible in-service distribution. There is no limit on the amount an employee can receive as a terminally ill individual distribution. The employee may recontribute any portion of a terminally ill individual distribution within three years from the distribution date to a qualified plan or an IRA in which the employee is a beneficiary and to which a rollover can be made.

Tax reporting

The terminally ill individual distribution is includible in the individual’s gross income. If a qualified retirement plan does not permit terminally ill individual distributions and an employee receives an otherwise permissible in-service distribution, the employee may treat the distribution as a terminally ill individual distribution on their federal income tax return if they meet the requirements for a terminally ill individual distribution and retain the physician’s certification and supporting documentation in their tax files for the year of distribution.

Interest crediting rate for cash balance plans

To satisfy the IRC benefit accrual rules, Section 348 of SECURE 2.0 provides that cash balance plans that use a variable interest crediting rate should use a reasonable projection of the variable interest crediting rate, not to exceed 6%. This section is effective for plan years beginning after December 29, 2022. Notice 2024-2 provides the following guidance:

Plans affected

These rules apply to defined benefit plans in which the accrued benefit is calculated as the balance of a hypothetical account for a participant (i.e., cash balance plans). Cash balance plans that provide pay credits that increase with the participant’s age or service, and which use a variable interest crediting rate, may also have in their plans a fixed annual minimum interest crediting rate to help satisfy the benefit accrual rules. Section 348 eliminates the need for this minimum rate.

Plan amendment

An amendment pursuant to Section 348 is made only if a cash balance plan provides for pay credits that increase with a participant’s age or service and the amendment changes the plan’s interest crediting rate, or if the plan is implementing such a pattern of pay credits as part of the amendment. The amendment may only change interest credits prospectively, beginning with interest crediting periods after the later of the effective date of the amendment or the date the amendment is adopted.

Exception to the anti-cutback rules

Interest credits specified under the plan that are not conditioned on future service are protected for benefits a participant has already earned under the IRC anti-cutback rules. Section 348 of SECURE 2.0 makes an exception to this rule for amendments affecting future interest crediting rates if:

• The plan’s interest crediting rate prior to the amendment is the greater of a fixed annual minimum rate, or the third segment rate under IRC Section 417(e)(3)(D), or a safe harbor interest rate specified in IRC regulations, and the amendment does one of the following:
  • Reduces or eliminates just the fixed minimum interest credit rate
  • Changes the interest crediting rate to an investment-based rate permitted by IRC regulations
• The plan’s interest crediting rate prior to the amendment is a fixed rate permitted by IRC regulations, and the amendment changes the interest crediting rate to any permitted variable rate, subject to a specified limit.

Other hybrid plans

The Treasury Department and the IRS do not expect Section 348 will impact a statutory hybrid plan that is not a cash balance plan. However, they are seeking comments as to whether there are plans other than cash balance plans that would be amended for Section 348.

We previously explored the impact of Section 348, noting that it could provide some plan sponsors the opportunity to provide higher benefit accruals to older, longer-service employees. Market-based cash balance plans have been in the spotlight in recent months, with IBM reopening its cash balance plan and other frozen or closed DB plans in a surplus position reviewing their options.

Plan amendment deadlines

Notice 2024-2 extends the deadlines for plan sponsors to adopt required and discretionary plan amendments related to SECURE 2.0. In general, a retirement plan will be treated as being operated in accordance with the terms of the plan and will not fail to satisfy the anti-cutback rules of the IRC or ERISA, if the plan amendment related to SECURE 2.0 or regulations thereunder meets the following three conditions.

1. The amendment is adopted no later than the due date in the table below.

2. The amendment applies retroactively to the effective date of the SECURE 2.0 provision or the regulations thereunder or, for discretionary plan amendments, the effective date specified by the plan.
3. The plan operates as if the amendment were in effect during the period beginning on the effective date in number 2 above, until the date the amendment is adopted.

Amendment deadlines for prior laws

The amendment deadlines in number 1 above also apply to provisions under the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act), the provision to lower the minimum age for in-service distributions in qualified pension plans and governmental 457(b) plans from age 62 to 59½ as provided by the Bipartisan American Miners Act of 2019 (Miners Act), coronavirus-related distributions and plan loan relief under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), and qualified disaster distributions under the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act).

Amendments made after these extended deadlines will not be entitled to IRC and ERISA anti-cutback relief.

Please contact your Milliman consultant with any questions.

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¹ A recently released discussion draft of technical corrections to SECURE 2.0 would clarify that, for purposes of Section 101 of SECURE 2.0, a plan maintained by more than one employer is a multiple-employer plan under IRC Section 413(c).