IRS Issues First Big Grab Bag of Guidance on SECURE 2.0 Act

On December 20, 2023, the Internal Revenue Service issued Notice 2024-02 (“Notice”), one of the promised grab bags of guidance for certain provisions of Division T of the Consolidated Appropriations Act, also known as SECURE 2.0 Act of 2022 (“SECURE 2.0 Act”).

The guidance covers a wide array of SECURE 2.0 Act provisions; however, some of the more complex items, such as the 2026 mandatory flip from 401(k) plan deferrals to Roth deferrals for certain highly compensated employees or student loan matching contributions, are not included. This guidance, which follows a Q&A format, includes the SECURE 2.0 Act provisions specifically described below.

Expanding Retirement Plan Participation Through Automatic Enrollment for New Plans

SECURE 2.0 Act provides that unless certain automatic enrollment requirements are satisfied (i.e., using an “eligible automatic contribution arrangement” (EACA) design) for plan years beginning after December 31, 2024, (1) a cash or deferred arrangement (CODA) will not be treated as a qualified CODA under Internal Revenue Code (“Code”) Section 401(k), and (2) an annuity contract purchased under a salary reduction agreement will not be treated as a qualified CODA under Code Section 403(b).

These requirements apply to plans adopted on or after December 29, 2022 (the “enactment date”). The Notice answers numerous questions regarding the determination of whether such qualified CODAs were established prior to the enactment date and, therefore, exempt from the SECURE 2.0 Act’s automatic enrollment requirements.

• First, the date a 401(k) plan providing a qualified CODA is actually adopted is key, even if the plan or CODA does not become effective until a later date. Thus, if the plan and its CODA provisions were adopted on December 1, 2022, before the enactment date, it would be exempt from the new requirements even if the plan or CODA is not effective until January 1, 2023, after the enactment date. (Similarly, for 403(b) plans the date of the plan’s adoption is determinative of its date of establishment, regardless of the date the salary deferral agreements are effective.)
• Second, there is very specific guidance associated with plan mergers. Depending on the status of the plan as pre-enactment or post-enactment and the timing of the merger, the ongoing plan may or may not be treated as a pre-enactment plan. Under these rules, if a pre-enactment plan and a post-enactment plan are merged, the resulting plan is generally treated as a post-enactment plan (unless the post-enactment plan was acquired in an M&A transaction and was merged into the pre-enactment plan before the end of the year after the acquisition occurred). So, plan mergers can easily cause the resulting plan to have to comply with the new automatic enrollment requirements. Therefore, in the event of M&A activity, care should be taken when dealing with a target’s 401(k) plan.

De Minimis Incentives for Plan Contributions

Under SECURE 2.0 Act, employers are permitted to offer immediate financial incentives to employees to encourage them to contribute to a 401(k) or 403(b) plan. The financial incentive cannot be paid for with plan assets. SECURE 2.0 Act does not define what “de minimis” is for these purposes. The Notice provides the following parameters:

• The value of the financial incentive must not exceed $250.
• The financial incentive can only be offered to employees for whom no election to defer salary is in place under the plan.
• A de minimis financial incentive can be provided in the form of installments, for example, a $75 gift card at the initial election to defer, a second $75 gift card after six months of deferrals, and a third $75 gift card if the deferrals have been continuous through the first year.
• A matching contribution cannot be a de minimis financial incentive.
• A de minimis financial incentive is not subject to plan contribution rules, such as qualification requirements or deductibility timing rules.
• The value of the financial incentive is treated as remuneration that is includible in the employee’s gross income and subject to withholding and reporting requirements for employment tax purposes unless the provision of the de minimis financial incentive satisfies exceptions to these requirements under the Code. Remember that cash equivalents, like gift cards, are always taxable income no matter the size of the amount.

Terminally Ill Individual Distributions

SECURE 2.0 Act provides that a participant who is terminally ill and takes a plan withdrawal will not be subject to the 10% tax on early distributions in certain situations. In order to get this tax-advantaged treatment, a physician must certify that the individual’s condition is reasonably expected to result in death within 84 months. The employee may repay the withdrawal to an IRA or qualified plan within three years.  This guidance provides answers to many of the questions surrounding this optional provision, including:

• A “physician” is generally defined as a doctor of medicine or osteopathy who is legally authorized to practice medicine and surgery by the State in which the doctor practices.
• The physician’s certification must include the following:
  • A statement that the illness or physical condition can be reasonably expected to result in death within 84 months or less after the certification’s date.
  • A narrative description of the evidence supporting the statement of illness or physical condition.
  • The name and contact information of the physician making the statement.
  • The dates of (1) the physician’s examination of the individual or the physician’s review of the evidence provided by the individual and (2) the certification.
  • The signature of the physician and an attestation from the physician that, by signing the form, the physician confirms that the physician prepared the narrative description of the examination of the individual or of the review of the evidence provided by the individual.
• The terminally ill individual distribution must be made on or after the date of the certification.
• There is generally no limit on the amount of the distribution.
• Terminally ill individual distributions are includible in gross income.
• Currently, such a terminally ill individual distribution can only be permitted by a plan if the distribution would fit within a type of distribution the law would otherwise permit the plan to make. SECURE 2.0 Act did not contain an express exception to the limitations on the situations in which 401(k) plans and pension plans may normally make distributions. (Congress is considering a technical corrections bill that would provide such an exception, but that is not yet law.)  So, for example, for a 401(k) plan, a terminally ill individual distribution would only be permissible if the terminal illness would also constitute a disability, create a hardship, or cause a termination of employment.
• To the extent a terminally ill individual distribution could fit within existing distribution rules, a plan can add provisions specifically related to such a distribution option, including, for example, the right to repay the withdrawal within three years. Plans are not required, however, to add specific terminally ill individual distribution provisions. Plans which may include terminally ill individual distribution provisions, subject to limitations of existing law, include qualified defined contribution and defined benefit plans, 403(a) annuity plans, 403(b) annuity contracts, 408(a) individual retirement accounts, and 408(b) individual retirement annuities.

In the event that a plan does not include specific provisions regarding terminally ill individual distributions, a participant may request an otherwise permissible in-service distribution and treat the distribution on his/her tax return as a terminally ill individual distribution.

Optional Treatment of Employer Contributions as Roth Contributions

SECURE 2.0 Act permits 401(k), 403(b) and governmental 457(b) plans to allow participants to elect to have matching and/or nonelective contributions made to their retirement accounts treated as Roth contributions. The Notice provides clarifications around the following aspects of this optional provision:

• Any designation of a matching or nonelective contribution as a Roth contribution must be irrevocable and made by the employee no later than the time the employer contribution is allocated to the employee’s account.
• A plan need not permit employees to designate elective contributions as Roth contributions in order to permit employees to designate matching and/or elective contributions as Roth contributions and vice versa.
• If such designations are permitted by a plan then it must permit employees to have an effective opportunity to make or change designations at least once during the plan year.
• A designated Roth matching or nonelective contribution is includible in the employee’s gross income for the taxable year in which the contribution is allocated to his/her account, even if such contribution is deemed to have been made on the last day of the prior taxable year, as permitted under the Code, for purposes of deductibility.
• An employee may not designate any matching contributions as Roth contributions unless he or she is already 100% vested in his matching contribution account. The same rule applies to designating nonelective contributions as Roth contributions.
• Designated Roth matching and nonelective contributions are not subject to federal income tax withholding and are not wages for purposes of the Federal Insurance Contributions Act (FICA) or Federal Unemployment Tax Act (FUTA) – just as matching and nonelective contributions generally would not be subject to income tax withholding or be subject to FICA or FUTA. Similarly, if the plan uses a safe harbor definition of compensation for Code Section 415 purposes, such contributions are not included in that compensation. In addition, such contributions must be reported using Form 1099-R for the year in which the contributions are allocated to the employee’s account. The total amount of designated Roth matching and nonelective contributions allocated in such year are reported in boxes 1 and 2a of Form 1099-R, and code "G" is used in box 7.

Safe Harbor for Correction of Certain Deferral Failures

The IRS Employee Plans Compliance Resolution System (EPCRS) had correction opportunities related to certain errors that were set to sunset as of December 31, 2023. SECURE 2.0 Act made permanent the principal feature of these provisions by allowing, under certain conditions, 401(k), 403(b) and 457(b) plans to correct reasonable administrative errors made as a result of (1) implementing an automatic enrollment or automatic escalation feature with respect to eligible employees or (2) failing to afford an eligible employee the opportunity to make an affirmative election because the employee was improperly excluded from the plan. The Notice specifies that for deferral failures that have a correction date prior to December 31, 2023, plan administrators can rely on reasonable good faith interpretations of the SECURE 2.0 Act provision. The Notice provides the following clarifications for automatic enrollment or automatic escalation failures that have a correction date after December 31, 2023:

• The date by which a plan administrator must implement correct deferrals is the earlier of (1) the date of the first payment of compensation made to the employee on or after the last day of the 9-1/2 month period after the end of the plan year during which an implementation error with respect to the employee first occurred, or (2) in the case of employee notification of the error, the date which is the first payment of compensation on or after the last day of the month following the month in which the plan sponsor is notified of the error. The deadline is the same for terminated employees, determined as if the termination of employment had not occurred.
• If an employee affected by the implementation error would have been entitled to additional matching contributions had the deferrals properly been made under the plan terms, a corrective allocation of matching contributions (adjusted for earnings) must be made within a reasonable period (applying all relevant facts and circumstances) after the date on which the correct elective deferrals begin (or would have begun but for the termination of employment). A corrective allocation of matching contributions made by the last day of the sixth month following the month in which correct elective deferrals begin (or would have begun but for the termination of employment) is considered to have been made within a reasonable period.

Plan Amendments – Extended Deadlines

The Notice clarifies when a retirement plan must be amended to reflect the applicable provisions of the SECURE Act, section 104 of the Miners Act (lowering the age to 59-1/2 for in-service distributions from qualified pension and governmental 457(b) plans), section 2202 or 2203 of the CARES Act (Coronavirus-related distributions or waiving mandatory required minimum distributions for 2020, respectively), section 302 of the Relief Act (qualified disaster distributions) and SECURE 2.0 Act (collectively, the “Acts”). In general, the deadlines for the adoption of an amendment to incorporate into the plan document the Acts’ provisions that were either mandatorily or optionally adopted are as follows:

Cash Balance Plans

SECURE Act 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 may allow plan formulas to provide higher annual contribution credits to longer-service employees and allows a plan sponsor to eliminate any minimum interest crediting rate provision in its cash balance plan. The Notice provides the following confirmations and clarifications:

• A cash-balance plan that provides for pay credits to participants that increase with age or service and provides for a variable interest crediting rate is not at risk of violating the accrual requirements if the interest crediting rate falls below a certain point.
• A cash-balance plan can be amended to adopt the new provisions if: (1) the plan currently provides for principal credits that increase with age or service and the amendment is revising the plan’s interest crediting rate, or (2) part of the plan’s amendment is implementing such a pattern of principal credits.
• An amendment to a cash-balance plan to adopt the new provisions can only be adopted with respect to interest credits for interest crediting periods beginning after the later of the amendment’s effective date and the amendment’s adoption date.
• The Notice details the requirements to comply with the exception from protected benefit requirements provided by the SECURE 2.0 Act in any amendment affecting future interest crediting rates.

Miscellaneous Guidance

Although beyond the scope of this article, other SECURE 2.0 Act provisions for which the Notice provides needed guidance include the credit for small pension plan start-up costs, small employer credit for military spouse eligibility in retirement plans, SIMPLE plan contribution limits, the replacement of a SIMPLE plan retirement account with a safe harbor 401(k) plan during the year, and SIMPLE and SEP Roth individual retirement accounts.

Your Calfee Attorneys Are Available To Answer Questions

If you have any questions about this SECURE 2.0 Act guidance, the SECURE 2.0 Act itself and its 2024 mandatory amendments and optional provisions, or any other amendment you are contemplating for your tax-qualified or other retirement plan, please contact any member of our Employee Benefits and Executive Compensation practice group.