The omnibus spending bill signed into law on Dec. 29, 2022 contains important tax provisions that can affect businesses. Included in the 4,000-page document is a 350-page package of changes to the tax rules governing employer-sponsored retirement programs such as 401(k), 403(b), and certain profit-sharing and stock bonus plans.
The package, commonly referred to as the SECURE 2.0 Act, makes dozens of important updates to the original Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019. In addition to increasing individual participants’ annual contribution limits and raising the age at which they must start taking distributions, the new law also contains many significant new requirements for employers.
While some of the changes took effect immediately, others are phased in over several years. Employers should begin working now to adapt their plans to comply with the new rules.
Enrollment and Eligibility
Under SECURE 2.0, any employer that establishes a new 401(k) retirement plan must automatically enroll employees as soon as they become eligible rather than allowing them to “opt in.” (Employees may still “opt out,” of course.)
This mandatory automatic enrollment requirement will take effect on Jan. 1, 2025, but it will apply to any new plan that was established after Dec. 29, 2022. Plans that were established earlier are exempt from the mandate, but they may choose to establish automatic enrollment if they have not already done so. Companies with 10 or fewer employees or that have been in business less than three years are also exempt.
For companies subject to the new mandate, each employee’s initial automatic contribution must be at least 3 percent of his or her eligible wages, up to a maximum of 10 percent. The contribution must automatically increase by 1 percent each year until it reaches at least 10 percent of eligible wages, up to a maximum of 15 percent.
The new law allows part-time employees to become eligible for a company’s retirement plan sooner, reducing the qualification period from three years of consecutive part-time employment to two years. This change also takes effect Jan. 1, 2025, which means employers should begin tracking hours for part-time eligibility this year.
Incentives to Encourage Participation
In addition to automatic enrollment, SECURE 2.0 contains other provisions intended to boost participation in employer-sponsored retirement plans. For the first time, employers are now permitted to offer de minimis financial incentives (such as gift cards) to encourage employees to enroll. The incentives cannot be paid for with plan assets.
Beginning in 2024, employees can use their student loan payments to qualify for matching employer contributions to their retirement plans. Also starting in 2024, employers with SIMPLE IRA plans will be able to make larger contributions to employee accounts.
Other inducements give participants greater flexibility in managing their retirement accounts. For example, effective immediately, employers may amend their plans so that employees can choose to have employer contributions made as Roth (after-tax) contributions instead of traditional pre-tax contributions. Beginning this year, employers can also make Roth contributions to SIMPLE and SEP IRAs. The new law also makes it easier for account holders to use retirement accounts for emergency expenses without incurring a tax penalty.
Incentives for Establishing New Plans
SECURE 2.0 includes new incentives to encourage companies that have not yet established retirement plans to do so now. For example, during the first three years of a new plan’s operations, a business with 50 or fewer employees could be eligible for tax credits equal to as much as 100 percent of the administrative costs of setting up the plan, up to a maximum of $5,000. That’s up from the previous 50 percent credit.
Small employers that join a multiple employer plan may also be eligible for this credit, enabling them to hold down costs by pooling resources with other companies. For companies with 50 or fewer employees, the new law also allows employer contribution credits of up to $1,000 per employee for the plan’s first five years. This incentive applies to existing plans as well.
Starting in 2024, employers that do not currently sponsor a retirement plan will be able to offer a simple “starter” 401(k) or “deferral-only” plan. Such plans do not include an employer match, so they are exempt from the traditional 401(k) testing requirements and other regulations designed to ensure employer contributions do not unfairly favor certain employees.
For sole proprietors, SECURE 2.0 now allows for retroactive first-year deferrals, which enable an owner to start a new solo 401(k) plan after the end of the tax year, and make a larger contribution than previously allowed.
Altogether, SECURE 2.0 encompasses about 90 separate tax provisions related to retirement plans; the ones mentioned here are only a small sample. Companies that sponsor plans should consult with their plan administrators to be sure all needed changes are made. They should also talk to their tax professionals to determine whether they should modify their plans to take advantage of some of the new SECURE 2.0 incentives.
Contact Holbrook & Manter for more information. We would be happy to assist you.