Given current circumstances, if you are at all concerned about your company’s ability to afford your 2020 defined benefit/cash balance pension plan contributions, you must consider action now that will allow you to reduce or eliminate the plan’s 2020 required contribution.
Most plans provide that benefits are “earned” once employees complete 1,000 hours during the year. For full-time employees, 1,000 hours is usually reached approximately June 21st for a calendar year plan. At least 15 days before this date, the plan may be “frozen” by providing a notice to plan participants and amending the plan to curtail benefits. Once amended, this will stop plan benefits from increasing, thereby eliminating the “normal cost”, typically the largest component of a plan’s required contribution. If the economy recovers quickly and 2020 turns out to be a good year, you may unfreeze the plan by amending before year-end to restore your plan contribution to its previous level.
If the plan is not amended to freeze benefits before the 1,000-hour threshold, it will be very difficult, if not impossible, to significantly reduce the 2020 required plan contribution.
Compounding this situation, if your plan investments have suffered losses in the stock market, the decline in value will tend to increase plan contributions. Depending on the value of your plan assets at the end of 2020, a contribution may still be required for the year even if the plan is frozen, though it will be much reduced from what it would be if the plan is not frozen.
Also, while this is hopefully premature, in recessions companies may need to reduce staff. Please be aware that the IRS considers a 20% reduction in plan participants to be a “partial plan termination.” In the event of partial plan termination, the tax code requires all affected participants to be fully vested in their plan benefits.
Finally, be aware that there are not currently any changes to the 2019 funding requirements (contributions due in 2020), but the IRS, DOL and PBGC are exploring the possibility of some sort of relief.
28th: Form 1099-R – The Form 1099-R is due for any distributions that occurred during the 2019 calendar year. Note: Participant Loans that are in default may be considered “deemed” distributions and are reportable on Form 1099-R.
15th: ADP/ACP Corrective Testing – Deadline for distributing contributions and earnings as corrective measures to ADP and ACP testing for calendar year plans. Corrective distributions made after the deadline will result in a 10% excise tax on the amount distributed.
15th: Employer Contributions – Deadline for contributing employer contributions for amounts to be deducted on 2019 S-corporation and partnership returns for filers with a calendar fiscal year (unless extended).
1st: Required Minimum Distributions – Regulations require that a participant must receive a required minimum distribution (RMD) by April 1st of the year following the year in which the participant attains age 70 ½. Distributions may be delayed until actual retirement unless the participant is a 5% or more owner.
15th: Excess Deferral Amounts – If a participant makes salary deferral contributions in excess of the IRS-issued limits in any calendar year, the plan must return the excess amount plus earnings to the participant by April 15 of the year following the year in which the excess occurred. The limits for 2019 were $19,000, or $25,000 for those age 50 and over if the plan allowed for catch-up contributions.
15th: Employer Contributions – Deadline for contributing employer contributions for amounts to be deducted on 2019 C-corporation and sole proprietor returns for filers with a calendar fiscal year (unless extended).
Domestic equity markets posted strong gains during the fourth quarter of 2019 with the S&P 500 Index increasing 9.07%. Market volatility was minimal in the quarter with major domestic indices continuing to reach all-time highs through December on the back of an accommodative Federal Reserve and a Phase One trade deal with China. The S&P 500 Index returned 31.49% over the course of year – the best yearly gain since 2013.
Equity performance was also strong across small- and mid-cap companies with the Russell 2000 Index and Russell Midcap Index returning 25.52% and 30.54%, respectively. Growth stocks once again outperformed their value counterparts across all market capitalizations. Except for the Real Estate sector’s -0.5% decline, all sectors were positive in the quarter. Technology continued its strong run, returning 14.4% in the quarter and 50.3% for the calendar year 2019. The Healthcare sector rebounded in the quarter returning 14.4%. High dividend paying defensive sectors like Utilities and Consumer Staples lagged the overall market as bond yields rose to become more attractive and risk-on sentiment thrived.
Equity markets outside of the U.S. posted strong gains in the fourth quarter with Emerging Markets leading the way with an 11.84% return. Chinese markets were a major driver of Emerging Market returns as positive news flow of a trade deal with the U.S. calmed investors. A decisive Conservative Party victory in Britain’s Parliamentary elections led to a strong rally in UK equity markets as investors saw a pathway forward to a final Brexit deal. Developed European markets moved higher on continued European Central Bank accommodation and hopes that major manufacturing centers were bottoming.
The Federal Open Market Committee (“FOMC”) cut interest rates by 25 basis points at their October meeting, leaving the target range for the federal funds rate at 1.50% to 1.75%. Fed Chairman Jerome Powell cited sluggish global weakness, the U.S.- China trade war, and uncertainties associated with Brexit as reasons for the additional rate cut, noting that inflation was not currently a concern. Chairman Powell also signaled this may be the final rate cut in this “mid-cycle adjustment” and stated the FOMC’s current rate stance of monetary policy was likely to remain appropriate. The yield on the 10-year Treasury rose from 1.68% to finish the quarter at 1.92%. The yield curve steepened as the FOMC’s rate cuts lowered the short end of the curve, and recessionary concerns for 2020 abated allowing longer-term rates to steadily rise.
The initial estimate of fourth quarter gross domestic product (GDP) was for 2.1% growth, bringing 2019 calendar year growth to 2.3%. Residential fixed investment, representing purchases of private residential structures and equipment, was the bright spot in the report and grew at a 5.8% pace. Personal consumption expenditures slowed but still grew by 1.8%, government spending was additive, and trade provided its biggest contribution to GDP in a decade as imports collapsed. One concern in the report was the negative contribution from business investment, which declined for the third straight quarter. Consumer confidence indices remained high but did tick down in December after a strong November reading.
The U.S. unemployment rate remained at 3.5% during the fourth quarter – its lowest level in 50 years. U.S. hiring picked up with the economy adding an average of 184,000 jobs per month during the quarter. The December Jobs Report saw continued increases in employment in the service sectors, especially education and health services, which is a trend that was present throughout the year. Average hourly wages continued to grow near a 3% rate throughout the quarter.
The year-over-year headline inflation rate increased to 2.3% during the quarter, with higher gasoline prices more than offsetting declines in used automobile prices and airline fares. During the same period, core inflation, which excludes food and energy, rose at a 2.3% rate with upward pressure in shelter and medical care services.
On December 20, 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law.
The SECURE Act represents some of the most significant changes to retirement plan law since the passage of the Pension Protection Act of 2006, over thirteen years ago. The provisions of the Act are broad ranging and span many different effective dates.
Financial Help for Plan Sponsors
Though tax credits have been in place to help offset the cost of adopting a new retirement plan, the SECURE Act significantly expands the tax credit for employers. Prior to the SECURE Act, employers were allowed a tax credit of the lesser of 50% of expenses or $500 per year for the first three years. Under SECURE, the amount of the tax credit is now raised to the lesser of 50% of expenses or $250 times the number of non-highly compensated employees eligible to a maximum of $5,000. Additionally, if the new plan enrolls employees into the plan using an automatic enrollment provision, the employer will get an additional annual credit for start-up costs of $500 per year. This credit is also available to existing plans that convert to an automatic enrollment design and the new credits apply to the first 3 years. These changes are effective for taxable years beginning after December 31, 2019.
Changes to 401(k) Plans
The SECURE Act also has provisions affecting 401(k) plans. These provisions are effective for plan years beginning after December 31, 2019.
Plans that elect to utilize a non-elective contribution (minimum of 3% of pay to all eligible participants) to satisfy the safe harbor provision, no longer need to distribute an annual safe harbor notice. Previously, the opportunity to make an annual safe harbor election was required to be made prospectively, no more than 90 days, or less than 30 days prior to the beginning of the plan year in which they would apply. Under SECURE, 401(k) plans can now be amended mid-year to elect safe harbor provided a non-elective contribution formula is used. These provisions do not apply to those plans utilizing matching contributions to satisfy safe harbor provisions.
The maximum percentage for automatic enrollment contributions has increased from 10 to 15% of compensation for qualified automatic contribution arrangement safe harbor plans.
Previously, part-time workers could be excluded from participating in a 401(k) plan if they had not worked 1,000 hours in a 12-month eligibility period. For plan years beginning after December 31, 2020, the SECURE Act requires employers to include long-term, part-time workers in 401(k) plans. Eligible employees must have at least 500 annual hours of service for three consecutive years and be age 21 or older. However, these participants can be excluded from safe harbor contributions, nondiscrimination testing and top-heavy requirements.
General Retirement Plan Changes
Beginning with forms required to be filed after December 31, 2019, SECURE has raised the late filing penalties for Form 5500 from $25 per day to $250 per day, not to exceed $150,000. For Form 8955-SSA, the penalty for late filing has increased from $1 per day for each day of late filing to $10 per participant per day, not to exceed $50,000. A Form 8955-SSA is required to be filed with respect to any plan participant who separated from service during the year and has a deferred vested benefit under the plan.
Prior to the SECURE Act, Required Minimum Distributions (RMDs) were required to begin no later than April 1st following the year in which a participant reached age 70 ½. Starting with participants obtaining age 70 ½ in 2020, the minimum distribution age has been raised to 72.
A disaster relief provision will apply to major disasters which occurred after 2017 through February 18, 2020. Under this provision, “qualified disaster distributions” of up to $100,000 are exempt from the 10% premature distribution penalty. A “qualified disaster distribution” is a distribution made to an individual who suffered an economic loss and whose principal residence is in a qualified disaster zone during the period of the disaster (as specified by the Federal Emergency Management Agency (FEMA)). In addition, the normal participant loan limit of $50,000 has increased to $100,000 for affected individuals.
SECURE also allows for penalty free withdrawals for expenses related to the birth or adoption of a child. The lifetime withdrawal amount is set at $5,000 and is effective for distributions made after December 31, 2019.
Pension Plan, IRA and other Changes
SECURE will require a lifetime income illustration on participant benefit statements. The legislation requires benefit statements provided to defined contribution plan participants to include a lifetime income disclosure at least once during any 12-month period. The disclosure would illustrate the monthly payments the participant would receive if the total account balance were used to provide lifetime income streams. The DOL is expected to give more definitive direction to the format and content of the illustrations. Compliance is delayed until 12 months after additional guidance is provided by the DOL.
SECURE provides a Fiduciary Safe Harbor for selection of Lifetime Income Providers within a retirement plan. The legislation provides protection from liability for fiduciaries for any losses that may result to the participant or beneficiary due to an insurer’s inability in the future to satisfy its financial obligations under the terms of the contract. Removing ambiguity about the fiduciary standard eliminates a roadblock to offering lifetime income benefit options under a defined contribution plan.
The SECURE Act also increases the portability of annuity investments by letting employees who take another job or retire move their annuity to another 401(k) plan or to an IRA without surrender charges and fees. Portability also comes into play if the lifetime income investment is no longer authorized to be held as an investment option under the plan (effective for plan years beginning after December 31, 2019).
The legislation repeals the prohibition on contributions to a traditional IRA by an individual who has reached age 70½. As life expectancy increases, there is an increased number of individuals continuing employment beyond the traditional retirement age.
Changes to Earliest Age for Pension Plan In-Service Retirement
Pension plans, such as defined benefit pension plans, money purchase pension plan, and hybrid plans, generally are not allowed to permit distributions before the earlier of retirement (i.e., termination of service) or normal retirement age. However, since 2007, current law has also permitted an employee to receive benefits while still in-service and before retirement, as long as the participant had reached age 62. The SECURE Act reduces the earliest age an employee can receive in-service retirement benefits from a pension plan from age 62 to age 59½. The change is effective for plan years beginning after December 31, 2019.
Changes for Defined Benefit Plans
SECURE modifies the nondiscrimination rules with respect to closed or frozen plans to permit existing participants to continue to accrue benefits. The modification will protect the benefits for older, longer tenured employees as they near retirement (effective on the date of enactment).
The Act also eliminates the so-called stretch IRA. Under current law, after the death of a plan participant or IRA owner, a non-spouse beneficiary is permitted to stretch the required minimum distributions over the beneficiary’s life based on his or her life expectancy. Under the new law, all amounts held by the plan or IRA must be distributed within 10 years of the plan participant’s or IRA owner’s death. An exception to the 10-year distribution rule is provided for an “eligible beneficiary,” which includes a surviving spouse, minor child, disabled or chronically ill individual, or any other beneficiary who is no more than 10 years younger than the participant or IRA owner. The new rules will apply to participants with a date of death after December 31, 2019.
With the scope of changes associated with SECURE, it is important to note that the act includes a remedial amendment period that allows plans to operate in accordance with the new law without having to immediately amend the plan. This remedial amendment period requires most plans to adopt conforming amendments by the end of the 2022 plan year. Government plans and collectively bargained plans will have an extended amendment period lasting until the end of the 2024 plan year.
The SECURE Act is obviously very broad in scope and may have changes that directly affect the future operation of many retirement plans. Please contact us with any questions or concerns.
The $1.4 trillion spending package enacted on December 20, 2019 and recently signed by the President, included the Setting Every Community Up for Retirement Enhancement (SECURE) Act, which overwhelmingly passed the House of Representatives in the spring of 2019, but then subsequently stalled in the Senate. The SECURE Act represents the most sweeping set of changes to retirement legislation in more than a decade. While many of the provisions offer enhanced opportunities for individuals and small business owners, there is one notable drawback for investors with significant assets in traditional IRAs and retirement plans. These individuals will likely want to revisit their estate-planning strategies to prevent their heirs from potentially facing unexpectedly high tax bills. Read more on this below. All provisions take effect on or after January 1, 2020, unless otherwise noted.
Elimination of the “Stretch IRA”
Perhaps the change requiring the most urgent attention is the elimination of longstanding provisions allowing non-spouse beneficiaries (usually one’s children) who inherit traditional IRA and retirement plan assets to spread distributions — and therefore the tax obligations associated with them — over their lifetimes. This ability to spread out taxable distributions after the death of an IRA owner or retirement plan participant, over what was potentially such a long period of time, was often referred to as the “stretch IRA” rule. The new law, however, generally requires any beneficiary who is more than 10 years younger than the account owner to liquidate the account within 10 years of the account owner’s death unless the beneficiary is a spouse, a disabled or chronically ill individual, or a minor child until they reach the age of majority. This shorter maximum distribution period could result in unanticipated tax bills for beneficiaries who stand to inherit high-value traditional IRAs. This is also true for IRA trust beneficiaries, which may affect estate plans that intended to use trusts to manage inherited IRA assets. If an individual currently has a trust named as a beneficiary, it is recommended to review and possibly update your estate plan. In addition to possibly reevaluating beneficiary choices, traditional IRA owners may want to revisit how IRA dollars fit into their overall estate planning strategy. For example, it may make sense to consider the possible implications of converting traditional IRA funds to Roth IRAs, which can be inherited income tax-free. Although Roth IRA conversions are taxable events, investors who spread out a series of conversions over the next several years may benefit from the lower income tax rates that are set to expire in 2026 .
Benefits to Individuals
On the plus side, the SECURE Act includes several provisions designed to benefit American workers and retirees.
• People who choose to work beyond traditional retirement age will be able to contribute to traditional IRAs beyond age 70½. Previous laws prevented such contributions.
• Retirees will no longer have to take required minimum distributions (RMDs) from traditional IRAs and retirement plans by April 1 following the year in which they turn 70½. The new law generally requires RMDs to begin by April 1 following the year in which they turn age 72. The RMD change to 72 only applies to those that turn 70½ in 2020 and beyond. Those that turned 70½ in 2019 are still under the old rules.
• The age for Qualified Charitable Contributions is still 70½, so individuals can make charitable contributions up to $100,000 directly from their IRA before RMDs begin at age 72, creating a unique opportunity for charitably included individuals.
• Part-time workers age 21 and older who log at least 500 hours in three consecutive years generally must be allowed to participate in company retirement plans offering a qualified cash or deferred arrangements. The previous requirement was 1,000 hours and one year of service. (The new rule applies to plan years beginning on or after January 1, 2021.)
• Workers will begin to receive annual statements from their employers estimating how much their retirement plan assets are worth, expressed as monthly income received over a lifetime. This should help workers better gauge progress toward meeting their retirement-income goals.
• New laws make it easier for employers to offer lifetime income annuities within retirement plans. Such products can help workers plan for a predictable stream of income in retirement. In addition, lifetime income investments or annuities held within a plan that discontinues such investments can be directly transferred to another retirement plan, avoiding potential surrender charges and fees that may otherwise apply.
• Individuals can now take penalty-free early withdrawals of up to $5,000 from their qualified plans and IRAs due to the birth or adoption of a child. The $5,000 amount is a per child limit and can be used for each subsequent child. Regular income taxes will still apply, so new parents may want to proceed with caution.
• Taxpayers with high medical bills may be able to deduct unreimbursed expenses that exceed 7.5% (in 2019 and 2020) of their adjusted gross income. In addition, individuals may withdraw money from their qualified retirement plans and IRAs penalty-free to cover expenses that exceed this threshold (although regular income taxes will apply). The threshold returns to 10% in 2021.
• 529 account assets can now be used to pay for student loan repayments ($10,000 lifetime maximum) and costs associated with registered apprenticeships.
Benefits to Employers
The SECURE Act also provides assistance to employers striving to provide quality retirement savings opportunities to their workers. Among the changes are the following:
• The tax credit that small businesses can take for starting a new retirement plan has increased. The new rule allows employers to take a credit equal to the greater of (1) $500 or (2) the lesser of (a) $250 times the number of non-highly compensated eligible employees or (b) $5,000. The credit applies for up to three years. The previous maximum credit amount allowed was 50% of startup costs up to a maximum of $1,000 (i.e., a maximum credit of $500). • A new tax credit of up to $500 is available for employers that establish an auto enroll feature on a SIMPLE IRA or 401(k) plan. This applies to any plan and not just new ones. The credit applies for three years.
• With regards to the new mandate to permit certain part-timers to participate in retirement plans, employers may exclude such employees for nondiscrimination testing purposes.
• Employers now have easier access to join multiple employer plans (MEPs) regardless of industry, geographic location, or affiliation. “Open MEPs,” as they have become known, offer economies of scale, allowing small employers access to the types of pricing models and other benefits typically reserved for large organizations. (Previously, groups of small businesses had to be affiliated somehow in order to join an MEP.) The legislation also provides that the failure of one employer in an MEP to meet plan requirements will not cause others to fail, and that plan assets in the failed plan will be transferred to another. (This rule is effective for plan years beginning on or after January 1, 2021.)
• Auto-enrollment safe harbor plans may automatically increase participant contributions until they reach 15% of salary. The previous ceiling was 10%.