On December 29, 2022, President Joe Biden signed the SECURE 2.0 Act of 2022 (“SECURE 2.0”) into law as part of the Consolidated Appropriations Act, 2023. SECURE 2.0 includes a wide range of changes geared toward expanding retirement plan access and encouraging retirement savings while building on certain provisions of the SECURE Act of 2019 (“SECURE 1.0”).
This advisory is the third of multiple client advisories addressing SECURE 2.0 and focuses on three notable changes related to: (1) participant options to designate employer contributions as Roth contributions; (2) matching contributions on student loan payments; and (3) establishment of, and contributions to, certain emergency savings accounts.
Our prior client advisories regarding SECURE 2.0 are found here.
Change Available Now:
Option to Designate Certain Employer Contributions as Roth Contributions
Under current law, employer contributions are made to retirement plans on a pre-tax basis, and taxes are paid on the contributions and any attributable earnings at the time of distribution. As briefly mentioned in a prior client advisory, SECURE 2.0 introduces a new option for 401(a), 403(b), and governmental 457(b) plans to permit participants to designate employer matching contributions (including matching contributions on qualified student loan payments, discussed below) and nonelective contributions as Roth contributions. As with participant Roth contributions, employer matching and nonelective contributions designated as Roth contributions are included in the participant’s gross income for the year of the contribution. Employer matching and nonelective contributions designated as Roth contributions must be nonforfeitable when made.
Note: Although this change is technically available to add now, plan sponsors will likely want to wait for additional guidance regarding implementation and mechanics. Additionally, payroll systems will need to be updated to facilitate these contributions, a likely time-consuming process for most administrators.
Note: If a plan allows this option, the employer Roth contributions must be fully vested. This option may not be attractive for plan sponsors who impose a vesting schedule on employer contributions and want to continue to apply that schedule.
Note: This option may be attractive to participants who are interested in using in-plan Roth conversions, but who are leery of the immediate taxation of a significant portion of their plan account at the time of conversion. This option will allow participants to spread out the taxation over time. Providing this new designation option to participants does not require a plan to offer in-plan Roth conversions.
Changes Available Starting in 2024:
Student Loan Payments as Eligible for Employer Matching Contributions
Student loan debt is a major stressor for many employees. Employees with debt often have to choose between paying down their student loans or saving for retirement. A program addressing both of these needs was previously approved by the IRS in a private letter ruling issued in 2018 to Abbott Laboratories. Other plan sponsors have been hesitant to adopt the same approach without formally approved guidelines that can be relied upon by all plan sponsors (because private letter rulings can only be relied upon by the applicant). Effective for plan years beginning after December 31, 2023, Congress has codified the ability for plan sponsors of 401(k), 403(b), and governmental 457(b) plans (“applicable plans”) to add this option. SIMPLE IRAs have similar rules, but a discussion of those rules is outside the scope of this advisory.
If implemented by a plan sponsor, an applicable plan can treat qualified student loan payments made by plan participants as deferrals eligible for employer matching contributions. “Qualified student loan payments” are payments made by a participant to repay a qualified education loan incurred on behalf of the participant, the participant’s spouse, or the participant’s dependent at the time the loan was taken. For the loan to be qualified, it must be used to pay for eligible expenses for a student who is enrolled at least half-time in a program of study leading to a degree, certificate, or other recognized educational credential at an institution of higher education. The loan must be taken for eligible expenses, which generally include tuition, fees, and coursebooks but do not include non-credit courses, room and board, insurance, sports, medical expenses (including health fees), or transportation.
Several requirements apply to employer matching contributions on qualified student loan payments.
- Qualified student loan payments are generally limited to the Code Section 402(g) limit, less the participant’s elective deferrals for the year.
Note: Although loan payments can be credited up to the 402(g) limit, plan sponsors will only credit payments that are eligible for matching contributions under the terms of the plan.
- The participant must certify annually to the employer that the qualified student loan payment has been made (the employer is entitled to rely on this certification).
Note: Employers will be able to establish reasonable procedures for participants to claim these matching contributions, including an annual deadline to do so (which cannot be earlier than three months after the end of the plan year).
- The applicable plan must provide matching contributions at the same rate for both elective deferrals and qualified student loan payments.
- Participants receiving matching contributions on qualified student loan payments must be otherwise eligible to receive matching contributions on elective deferrals.
- All participants eligible to receive matching contributions on elective deferrals must be eligible to receive matching contributions on qualified student loan payments.
- The applicable plan must provide that matching contributions on qualified student loan payments vest in the same manner as matching contributions on elective deferrals.
SECURE 2.0 provides relief for nondiscrimination testing under Code Section 410(b) for matching contributions on qualified student loan payments and permits separate testing of these contributions for purposes of ADP nondiscrimination testing.
Note: These matching contributions also will be eligible to be designated as Roth contributions if an applicable plan decides to add the qualified student loan matching feature discussed above. However, if the Roth designation option is permitted, it would appear that all matching contributions to the plan would need to be fully vested immediately to meet the applicable vesting requirements of that new provision.
Note: We expect this optional feature will be one of the more popular features of SECURE 2.0 because it addresses a need to give employees the ability to save for retirement while also paying down student loan debt.
Emergency Savings Accounts
Effective for plan years beginning after December 31, 2023, plan sponsors of individual account plans (e.g., 401(a), 403(b) and governmental 457(b) plans) may (but are not required to) offer pension-linked emergency savings accounts (“ESAs”) for eligible participants. Under the new ESA rules, eligible participants may elect, at least once per calendar month, to receive partial or full withdrawals for any reason from their ESAs without penalty (these withdrawals are exempt from the age 59-1/2 early withdrawal penalty and are treated as if they meet the requirements for qualified Roth distributions and the restrictions on distributions of elective deferrals from applicable plans). Distributions must be made as soon as practicable following the election. Plan sponsors may make ESAs available to participants or may automatically enroll eligible participants pursuant to an automatic contribution arrangement at a rate of up to 3% of compensation. SECURE 2.0 provides for pre-emption of state law, such as anti-garnishment laws, which would otherwise prohibit the use of an automatic contribution arrangement.
Note: ESAs are only available to participants who meet all eligibility requirements under the plan and are not highly compensated employees. If a participant has an ESA and later becomes a highly compensated employee, they can keep the account and take withdrawals but cannot make any additional contributions.
Note: The goal of ESAs appears to be to give eligible participants easier access to money whenever the need might arise. However, administering the ability to take withdrawals from ESAs will significantly increase the cost of administering the plan.
Note: While the title implies that ESAs are available only in cases of emergency, the Internal Revenue Code and ERISA do not require any certification or determination of hardship.
Here are a few notable requirements applicable to ESAs.
- ESAs must be designated Roth accounts and cannot require a minimum contribution or account balance.
Note: Some have referred to ESAs as “side-car accounts.” These accounts are separate from traditional participant contribution accounts, but they are counted as elective deferrals for purposes of the 402(g) limit. If a participant contributes to an ESA for a calendar year, that amount will reduce the amount that can be contributed as a deferral under the traditional account.
Note: ESA distributions are treated as qualified distributions from designated Roth accounts (i.e., the distributions are not includable in gross income).
Note: ESA distributions are not treated as eligible rollover distributions unless the distribution is in connection with termination of the participant’s employment or termination of the ESA. Upon such termination, amounts in the ESA must be available for transfer to another designated Roth account for the participant under the plan (if any), and the transfer will be treated as an eligible rollover distribution. Any amounts that are not so transferred must be made available to the participant within a “reasonable time” (these amounts do not appear to be treated as eligible rollover distributions).
- Only participants can make contributions to ESAs. Employer contributions to ESAs are not permitted– except that contributions to an ESA must be eligible for employer matching contributions at the same rate as any other matching contributions on participant elective contributions, and employer matching contributions on contributions to ESAs must be made to an employer contribution account (not the ESA).
- ESAs cannot accept contributions of more than $2,500 (indexed) or a lesser amount established by the plan sponsor. Contributions that would cause the account to exceed this limit must, if the participant has another designated Roth account in the plan, be contributed to such other Roth account. If there is no other designated Roth account, the contributions cannot be accepted.
Note:Unlike other plan limits, this limit is an overall cap on contributions, not an annual cap. This will require additional monitoring.
- Amounts in ESAs must be held as cash in an interest-bearing deposit account or in certain investment products prescribed in SECURE 2.0. For plans subject to ERISA, participants are treated as exercising control over the assets for purposes of ERISA Section 404(c).
Note: While these accounts will likely not accrue significant earnings, an ESA will still meet the requirements if its earnings cause the ESA to exceed the contribution limits discussed in the prior bullet.
- The plan administrator must provide notices to the participants not less than 30 and not more than 90 days prior to the first contribution (or the date of an amendment to the sponsor-selected contribution rate). SECURE 2.0 specifies certain content and style requirements for this notice.
- No fees or charges can be applied on the basis of participant withdrawals for the first four withdrawals in a plan year (reasonable fees or charges may apply to subsequent withdrawals).
SECURE 2.0 directs the IRS, in consultation with the DOL, to prescribe regulations or other guidance no later than December 29, 2023 with respect to certain ESA anti-abuse rules set forth in SECURE 2.0. Additionally, the IRS is directed to prescribe regulations for ESA reporting and disclosure requirements.
Note: Plan sponsors who want to offer participants the ability to take small emergency withdrawals but do not want to deal with the significant administrative burden of ESAs, may want to consider the option to add withdrawals for certain emergency expenses under Section 115 of SECURE 2.0 (relating to withdrawals for certain emergency expenses). This new withdrawal right will be available in 2024 as well, does not require a special account, and will allow one penalty-free withdrawal of up to $1,000 annually for certain emergency expenses. We will have more information about this new option in a later client advisory.
Amendments required to comply with SECURE 2.0 must be adopted on or before the last day of the first plan year beginning on or after January 1, 2025 (January 1, 2027 for governmental and applicable collectively bargained plans), but plan sponsors may want to think about these changes now to prepare. Plan administrators will need to ensure their plans are being operated in compliance with applicable SECURE 2.0 requirements as of their applicable effective dates pending remedial amendment.
If you have any questions or need any additional information, please reach out to an attorney in the Employee Benefits Group for more information.