The SECURE Act: What plan sponsors need to know
A new bipartisan bill in Congress, the Setting Every Community Up for Retirement Enhancement Act of 2019 (H.R. 1994),1 or the SECURE Act, could improve employees’ ability to plan and save for retirement, but it would also give plan sponsors some new responsibilities. Passed by the US House of Representatives on May 23, 2019 and currently awaiting a Senate vote,2 the SECURE Act, as currently drafted, would make several changes of potential importance to plan sponsors. These changes include.
Allowing long-term, part-time workers to participate in 401(k) plans.This change would, except in the case of collectively bargained plans, require 401(k) plans to permit employees to make elective deferrals if they have worked at least 500 hours per year with the employer for at least three consecutive years and have met the age 21 requirement by the end of the three-year period. Since the US Bureau of Labor Statistics reports that millions of US workers are part-time employees,3 this part of the bill could have a substantial impact.
Simplification of safe harbor 401(k) rules. The legislation would eliminate the safe harbor notice requirement for safe harbor plans that provide for nonelective employer contributions of at least 3% of employee compensation (rather than employer matching contributions). Employers would have the ability to retroactively convert their plans to nonelective safe harbor status at any time prior to the last 30 days of the plan year. The change could be made as late as the end of the following plan year if a 4% nonelective contribution was made. Another provision would increase the cap on default rates under the auto enrollment safe harbor from the current 10% of compensation to 15% of compensation for years after default contributions have begun.
Fiduciary safe harbor for selection of lifetime income provider. This set of changes would provide certainty for Defined Contribution (DC) plan sponsors in the selection of annuity providers, a fiduciary act under ERISA. Fiduciaries would be offered an optional safe harbor with protection from liability for any losses that may result to a participant or beneficiary due to an insurer’s inability in the future to satisfy its financial obligations under the terms of the contract.
Portability of lifetime income options. The legislation would allow qualified DC plans, as well as Section 403(b) and Section 457(b) plans, to transfer lifetime income investments to another employer-sponsored retirement plan or IRA or distribute them in the form of an annuity. However, portability would be allowed only if the lifetime income investment was no longer authorized as an investment option under the plan. This change would allow participants to preserve their lifetime income investments and avoid surrender fees. A related provision would require that benefit statements for DC plan participants include a lifetime income disclosure at least once a year. This disclosure would show the monthly payments participants would receive if their total account balance were used to provide lifetime income streams.
Penalty-free withdrawals from retirement plans for the birth or adoption of a child. This change would allow plan participants to withdraw up to $5,000, penalty free, from their plan accounts within the one-year period following the birth or adoption of a child. Withdrawn amounts could later be recontributed to the plan tax free, subject to certain requirements.
Increase in age for required beginning date for mandatory distributions.To factor in increased life expectancy, the legislation would raise the age at which plan participants and IRA owners are generally required to start taking minimum distributions from 70½ to 72 years old. A related change would generally require beneficiaries of plan participants (and IRA owners) to take distributions by the end of the tenth calendar year following the death of the participant. There would be exceptions for surviving spouses, disabled or chronically ill beneficiaries, beneficiaries who are not more than 10 years younger than the participant and minor children of the participant.
The bill also contains several other provisions that employers should note, including:
- Forming multiple employer plans (MEPs). The legislation would allow employers with no common interest to combine forces and form an MEP. Each employer in a plan with a “pooled plan provider”—an outside provider responsible for administering the plan—would be treated as the plan sponsor with respect to the portion of the plan attributable to its own employees. Each plan sponsor would need to provide the plan provider with any information necessary to administer the plan. And to the extent not otherwise delegated by the plan provider to another fiduciary, each employer would have fiduciary responsibilities regarding the investment and management of its portion of the plan assets. In addition, there is protection from the “one-bad-apple” rule so that one employer’s failure to keep its part of the MEP in compliance would not result in disqualification of the entire plan.
- Creating incentives for small employers to offer retirement plans.Another provision would increase the credit for plan start-up costs to make them more affordable for small employers, while a related change would create a new tax credit for starting a 401(k) or SIMPLE IRA that includes an automatic enrollment feature or for converting an existing plan to an automatic enrollment design.
- Repealing the age limit on IRA contributions. This change would repeal the current age limit of 70½ years old for making contributions to a traditional IRA.
- Preventing retirement savings from being otherwise directed.While some retirement plans offer participant loans through a credit card or some similar arrangement, this change would prohibit this option with the aim of better preserving participants’ retirement savings.
- Plans adopted by the tax return filing due date for the year may be treated as in effect as of the close of the year. This change would offer employers more time to establish a plan and give participants the chance to receive contributions for that earlier year.
- Combined annual reports for group of plans. This change would direct the Internal Revenue Service and the Department of Labor to accept the filing of a consolidated Form 5500 for similar plans, thereby reducing aggregate administrative costs and making it easier for small employers to initiate and sponsor a retirement plan.
- Increased penalties for failure to file retirement plan returns. The intent of this increase is to encourage plan sponsors to file their plan information in a timely and accurate manner, as well as to improve tax administration.
The next step would be for the Senate to debate the bill’s contents. If the Senate has changes, the bill would be sent back to the House. If the Senate approves the bill with no changes, the bill would then be passed along to the President to sign into law or veto.
Preparing for retirement: What workers are doing and what stands in their way
The topic of retirement security has been front and center for plan sponsors, participants and employers for several years. Plan sponsors are very aware that many of their employees are stressed about their finances and worry about their ability to save or participate in their employer-provided retirement plans. The Employee Benefit Research Institute’s (EBRI) 2019 Retirement Confidence Survey examines in detail the extent of employee stress, the causes for this stress and how employees are confronting the barriers that stand in their way. Interestingly, the research also illustrates the steps employers can take to help move employees closer to retirement security.
Feeling stressed about preparing for retirement
The EBRI survey found that 20% of workers said they “strongly agree” and 39% “somewhat agree” with the statement that preparing for retirement makes them feel stressed. Workers say debt and competing financial priorities negatively impact their ability to save for retirement. The research found that debt is a huge roadblock to retirement and overall financial wellness.
To what extent does non-mortgage debt impact the following?
Save for emergencies
Save for retirement in general
Participate in or contribute to an employer’s retirement plan
Participate in or buy other employee benefits, such as life or disability insurance
Moreover, 55% of surveyed workers agreed that they are not able to save for retirement and save for other financial goals at the same time.
The current status of American workers
A sizeable percentage of workers report no or very little money in savings and investments. Nineteen percent report having less than $1,000 in savings and 40% report having less than $25,000. However, workers with a retirement plan have significantly more in savings and investments than those without a plan.
Worker savings amounts by plan vs. no plan
The Retirement Confidence Survey found that over six in 10 workers (66%) said that they or their spouses have saved money for retirement. Sixty-one percent report that they are currently saving for retirement. The survey iterates that the presence of a retirement plan at work clearly encourages employees to save for retirement.
Worker retirement savings behavior, by plan or no plan
Have personally saved any money for retirement
Are currently saving for retirement
What steps have workers taken?
Workers who calculate how much money they will need to live a comfortable retirement are more likely to actually do something positive to achieve that goal. The survey found, for example, that workers reporting that they or their spouse participate in a retirement plan are significantly more likely than those who do not participate to have attempted to calculate how much money they will need to save in order to live comfortably in retirement (50% versus 12%).
Other steps that workers report they have taken to prepare for retirement:
- 39% estimate how much income they would need each month in retirement.
- 37% calculate how much money they would need to save by the time they retired for a comfortable retirement.
- 33% have thought about how much money to withdraw from their retirement savings and investments in retirement.
- 31% have planned for an emergency expense in retirement.
- 29% calculate how much they would need for retirement health expenses.
What plan sponsors can do
The research found that workers believe there are things that plan sponsors can do to help them with their retirement savings.
- 22% say education or advice on how to manage competing financial priorities would be “very helpful.”
- 20% say help with basic budgeting and day-to-day finances would be “very helpful.”
- 17% say student loan debt assistance would be “very helpful.”
Measuring and predicting retirement income adequacy is important for plan sponsors and employers since it can help them benchmark their plans with their competitors. A deeper understanding of the issue can help them identify deficiencies in their own plans and take steps to realign their plans to better meet the needs of their employees.
Keeping a 401(k) safe harbor plan in compliance
401(k) safe harbor plans are widely used by employers—and for good reason. With a safe harbor plan design, yearly nondiscrimination testing of 401(k) salary deferrals and employer matching contributions is not required and highly compensated employees have the opportunity to maximize their deferrals. As with other qualified retirement plans, however, a 401(k) safe harbor plan must satisfy several ongoing requirements to maintain its status and stay in compliance. What follows is an overview of key requirements.
One of the tradeoffs associated with sponsoring a 401(k) safe harbor plan is that the employer must make specified contributions to the plan.
ADP test safe harbor. To eliminate the need for actual deferral percentage (ADP) testing, the employer must make nonelective contributions for all eligible employees or matching contributions. Nonelective contributions must equal at least 3% of compensation. The basic safe harbor matching formula is 100% of deferrals up to 3% of compensation and 50% of deferrals from 3% to 5% of compensation.4
Note that a plan may use an alternative matching formula, but it must meet the following conditions:
- The aggregate match amount at each level must equal or exceed the amount determined using the basic formula.
- The match rate cannot increase as the deferral rate increases.
- The match rate applicable to any eligible highly compensated employee cannot be greater than the match rate applicable to any eligible non-highly compensated employee who has the same rate of elective deferrals.5
ACP test safe harbor. To satisfy the actual contribution percentage (ACP) testing safe harbor, a plan should limit matching contributions to no more than 6% of compensation and discretionary matching contributions to no more than 4% of compensation. Additionally, matching contributions for highly compensated employees may not exceed those made for non-highly compensated employees at any rate of deferral. Lastly, the matching contributions may not increase as the employee deferral rate increases.6
Safe harbor contributions must be 100% vested when made and be subject to the same withdrawal restrictions that apply to salary deferrals made under the 401(k) plan.7
A safe harbor plan must distribute a written notice to employees who are eligible for plan participation. The notice, which must be written in a manner understandable to the average eligible employee, should include the following information:
- The safe harbor matching or nonelective contribution formula
- Any other employer contributions under the plan—including the potential for discretionary matching contributions—and the conditions under which these contributions will be made.
- The identity of the plan to which the safe harbor contributions will be made if it is different from the 401(k) plan.
- The type and amount of compensation that may be deferred.
- How a deferral election is made.
- The periods available for making the election.
- The plan’s withdrawal and vesting provisions.
- How to obtain additional information about the plan—telephone numbers, addresses and e-mail addresses of individuals or offices that will provide the information.8
The safe harbor notice must be provided within a reasonable period before the beginning of each plan year.9 Notices are deemed timely if they are provided at least 30 days and not more than 90 days before the plan year begins.10 Outside of this window, the Internal Revenue Service (IRS) considers all the relevant facts and circumstances in determining whether the timing requirement has been satisfied.11 Safe harbor notices must also be distributed to any employees who become eligible for participation during the year, generally at least 30 (and not more than 90) days before their eligibility date.12
Notices for qualified automatic contribution arrangement (QACA) safe harbor plans must include additional information:
- The level of elective contributions that will be made on the employee’s behalf if the employee does not make an affirmative election.
- The employee’s right to elect not to have elective contributions made or to elect to have these contributions made at a different percentage of compensation.
- How contributions under the automatic arrangement will be invested.
- For an arrangement that provides two or more investment options, how contributions will be invested in the absence of the employee’s investment election.13
Although the IRS permits employers to make various changes to their safe harbor plans during the plan year, certain mid-year changes are prohibited. For example, a mid-year change that reduces the number of employees currently eligible to receive safe harbor contributions would not be allowed. Plan sponsors can find more information regarding mid-year changes to safe harbor plans and notices on the IRS’s website.14
If your company sponsors a 401(k) retirement savings plan, you probably make a concerted effort to get your employees into the plan. But once they’ve enrolled, do employees contribute regularly and invest appropriately? A recent study from the Employee Benefit Research Institute (EBRI) and the Investment Company Institute (ICI) highlights just how important consistency can be when saving and investing for retirement.1
The study tracked the accounts of 6.1 million individuals who consistently participated in their employers’ 401(k) plans for a six-year period, from 2010 through 2016. The group was a subset of the larger EBRI/ICI database of 27.1 million participant accounts. Following are some of the study’s key findings.
As noted in the study, three factors affect the change in a participant’s account balance:
- New contributions made by the participant, the employer, or both
- Total investment return on the account balance, which is a function of the account’s asset allocation and financial market performance
- Any withdrawals, borrowing, and loan repayments
The average account balance of the consistent participants more than doubled during the period studied, rising from $75,378 at year-end 2010 to $167,330 at year-end 2016. This represents a compound annual average growth rate of 14.2% over the six-year period. The consistent participants’ average account balance was more than two times larger than the average balance of the larger participant group.
Average 401(k) account balance 2016—Consistent participants
Similarly, the median account balance among consistent participants more than doubled during the six-year period, from $30,114 to $82,338 by the end of 2016 (a compound annual average growth rate of 18.3%). This median balance was almost five times the $16,836 median balance for participants in the entire database.
Average asset allocation
Although many participants held a range of investments, their account balances tended to be weighted toward equities, through investments in equity funds, the equity portion of target-date and balanced funds, or company stock. At year-end 2016, equities represented approximately two-thirds of the account assets for both the consistent participant group and participants in the larger database, with younger participants tending to hold higher concentrations of equity investments than older participants.
Average asset allocation 2016—Consistent participants
Non-target-date Balanced Funds
GICs/Other Stable Value Funds
The researchers observed that the general rise in the stock market over the six-year period tended to boost the account balances of participants who held equities in their accounts.
Know your fiduciary responsibilities
As a plan sponsor, you want your retirement plan to serve as a competitive employee benefit—one that assists the company in recruiting and retaining the workers needed to help drive business success and helps them accumulate the savings they’ll need for the future. But as worthwhile as offering a workplace retirement plan can be, it also involves specific fiduciary responsibilities that are important for employers to understand.
Identifying plan fiduciaries
A plan’s fiduciaries are the individuals (and entities) who exercise discretion or control over the plan. The list of fiduciaries typically includes the plan’s trustee and investment advisors, any other individuals who exercise discretion in the administration of the plan, all members of the plan’s administrative committee (if there is one), and the individuals who select committee officials.2
Plan fiduciaries who fail to follow certain standards of conduct may be held personally liable to restore any losses to the plan, or to restore any profits made through the improper use of the plan’s assets resulting from their actions.3 The potential for personal liability makes it all the more critical for fiduciaries to be familiar with their roles and responsibilities to the plan and its participants.
Federal pension law requires plan fiduciaries to fulfill their duties to the plan solely in the interest of plan participants and beneficiaries.4 There are four primary responsibilities:
1. Act for the exclusive purpose of providing benefits to plan participants and beneficiaries and defraying reasonable plan administrative expenses5
Plan fiduciaries must avoid acting in their own interest rather than in the best interest of the plan’s participants and beneficiaries. Assets of the plan may be used to pay for plan administration, but the costs must be reasonable.
In addition to evaluating the reasonableness of plan administrative expenses, fiduciaries should consider how the expenses are allocated. For example, it may be appropriate to pay certain expenses, such as a fee for processing a hardship withdrawal, from the account of the affected participant while allocating other expenses, such as plan auditing fees, among all participants’ accounts. The plan document may describe the appropriate method for allocation.6 Note also that certain costs related to the establishment, design, and termination of a plan—so-called “settlor” functions—may not be paid from the plan.7
2. Act prudently with respect to plan assets8
This duty requires expertise in various areas, such as investments. Implicit in the prudence requirement is the need to monitor plan investment options. The ongoing investment review should generally encompass various measures, such as a comparison of recent performance data relative to an appropriate peer group and benchmark indexes and an assessment of any changes to portfolio managers, investment strategy, or fees.
Plan sponsors who don’t have the expertise necessary to carry out investment or other plan-related functions prudently can hire outside parties with professional knowledge to assist them. However, the plan sponsor remains responsible for following a prudent selection process. This generally entails vetting several potential providers, outlining specific requirements, and requesting the same information from each candidate so that a meaningful, objective comparison that considers all relevant factors can be made. The selection process, including the basis for any decisions made, should be documented and the selected provider’s services should be reviewed at reasonable intervals to ensure the provider is performing the agreed-upon services.9
3. Diversify the assets of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so10
Fiduciaries generally should avoid investing a disproportionately large amount of the plan’s assets in a single security or single type of security, unless the investments themselves are adequately diversified (as may be the case with mutual funds, for example).11 Similarly, a participant-directed plan should provide adequate opportunity for participants to diversify their account investments.
Where Section 404(c) compliance is sought, the plan should have a core investment menu consisting of at least three diversified alternatives, each having different risk and return characteristics.12 In addition, participants must be given sufficient information to make informed decisions about the plan’s investment options and be allowed to give investment instructions at least once a quarter, or perhaps more frequently if the investment option is volatile.13
4. Comply with the provisions of the plan14
Because the plan document serves as the foundation for plan operations, plan fiduciaries should be familiar with its terms. It’s also important to review the plan document periodically and to make sure that any amendments necessary to keep it current are made in a timely manner.15
When should 401(k) contributions be deposited?
Among their other fiduciary duties, 401(k) plan sponsors are responsible for ensuring that employees’ plan contributions and loan repayments are deposited into the plan trust in a timely manner. The sooner funds are deposited in the plan, the earlier they can be invested on plan participants’ behalf. Late deposits of salary deferral contributions must be reported on Form 5500, Annual Return/Report of Employee Benefit Plan, and are considered “prohibited transactions” that can give rise to fiduciary liability and excise taxes.
Know the rules
Under the applicable Department of Labor regulations, participant contributions to a 401(k) plan, as well as amounts representing repayment of participant loans, become assets of the plan as of the earliest date on which they can reasonably be segregated from the employer’s general assets.16 However, in no event may deposits be made later than the 15th business day of the month following the month in which the employer receives the amounts or withholds them from participant wages.17
It is important to recognize that the 15th business day represents an outside limit of the time that may be considered for segregation of the assets. If contributions and loan repayments can reasonably be segregated and deposited into the plan sooner, they must be. Many employers have payroll and accounting systems that make it possible for contributions and loan repayments to be segregated from general assets and deposited within a matter of days.
Safe harbor for small plans
The regulations provide a safe harbor period for employers to submit employee contributions and loan repayments to a plan that has fewer than 100 participants at the beginning of the plan year. Under this safe harbor, employers that deposit these funds within seven business days after the amounts are withheld from employees’ wages or received by the employer will automatically satisfy the law’s requirements. If a deposit is made later than seven days after the payroll date, it will not be considered a prohibited transaction as long as the deposit was made as soon as the contributions could reasonably be segregated from the employer’s assets (and not after the 15th business day of the month following the payroll month).18
Delinquent participant contributions and participant loan repayments are on the list of transactions that may be corrected under the Department of Labor’s Voluntary Fiduciary Correction Program (VFCP).19 To use the VFCP program, an applicant must restore the plan, participants, and beneficiaries to the condition they would have been in had the breach not occurred. An application is then submitted to the Employee Benefits Security Administration demonstrating that the violation has been self-corrected in accordance with the required correction method, which includes restoring any lost earnings to the plan. Upon successful completion of the VFCP process, the Department of Labor may issue a “no-action” letter with respect to the violation.