The Federal Trade Commission published a proposed rule[1] Jan. 5 that would effectively prohibit noncompete clauses for employees and other workers in all but very limited circumstances.[2]

This article focuses on the impact the proposed rule could have on employee benefit and compensation arrangements, if it becomes effective in its current form.

Golden Parachute Implications

Sections 280G and 4999 of the Internal Revenue Code may impose excise taxes and a loss of deduction on golden parachute compensation and benefit packages paid out to executives upon a change in control of their employer.

However, Section 280G does not apply to any reasonable compensation for services rendered by the employee after the date of a change in control. This includes compensation for refraining from performing services pursuant to a noncompetition provision.

Thus, noncompetes have often been used to mitigate potential Section 280G excise taxes and deduction losses that would otherwise apply to change-in-control payments and benefits. 

The proposed rule would eliminate this strategy.

In such a case, employers that have recently undergone a change in control would also need to consider updating their Section 280G calculations and, potentially, conducting a supplemental Section 280G shareholder vote.

Contractual Implications

Many employment agreements and incentive arrangements provide that post-termination payments will cease — and, in the case of clawback provisions, that previous payments must be repaid — if the worker violates the agreement. This can apply to noncompete provisions. In many cases, post-termination payments exist, in part, to protect the employer from damaging competition following the departure of the worker.

It is not entirely clear if these employee choice provisions — that is, to either comply with the noncompete requirements or forfeit future payments, and perhaps even repay prior ones — would be permitted under the proposed rule. The rule relies on a functional test to assert that provisions that effectively prohibit post-separation employment or business operation are de facto noncompetes.

In the absence of additional clarification, it would be risky to use such provisions.

Awards Subject to Substantial Risk of Forfeiture

Pursuant to Section 83 of the Internal Revenue Code, the fair market value of property, such as certain equity grants, transferred for the performance of services is generally included in the recipient’s income in the year that the right to the property becomes transferable or not subject to a substantial risk of forfeiture, whichever occurs first.

The Treasury regulations promulgated under Section 83 provide that

An enforceable requirement that the property be returned to the employer if the employee accepts a job with a competing firm will not ordinarily be considered to result in a substantial risk of forfeiture unless the particular facts and circumstances indicate to the contrary.[3]

The Treasury regulations provide a list of factors to be used in this analysis. Therefore, even before the proposed rule, how effective noncompete conditions were in deferring taxation of Section 83 property was questionable. But, even if an employer relies on a noncompete condition alone, without requiring continued employment, to defer the taxation on some Section 83 property, that property will become immediately taxable if the proposed rule takes effect in its current form.

The proposed rule would similarly affect the timing of Federal Insurance Contributions Act taxation of amounts deferred under employers’ nonqualified deferred compensation plans pursuant to a special timing rule under Section 3121(v)(2) of the Internal Revenue Code, which generally follows the timing of tax recognition under Section 83.

Accordingly, if an employer relies on a noncompete condition alone, without requiring continued employment, to defer the FICA taxation of amounts deferred under its nonqualified deferred compensation plan, such amounts will become immediately taxable for FICA purposes if the proposed rule becomes effective.

In our experience, most employers rely on continued employment, rather than a noncompete condition, to achieve Section 83 and FICA deferral. Therefore, the proposed rule would likely have limited impact in this area.

Nonqualified Deferred Compensation Plans of Tax-Exempt Entities

The proposed rule provides that employers exempt from coverage under the Federal Trade Commission Act are not subject to the proposed rule.

Thus, it appears that Section 501(c)(3) entities, including large hospital systems and universities, would not be prohibited from using noncompete clauses by these rules. As long as these organizations are not covered by the FTC Act, their Section 457(f) plans that vest contingent on compliance with a noncompetition agreement should not be adversely affected.

However, various questions remain, including whether broad noncompetes that cover the for-profit affiliates of Section 501(c)(3) entities could be subject to the proposed rule.

Key Takeaways for Employers

It is widely expected that the proposed rule will evolve before it becomes effective, if ever. However, to mitigate future risk, employers can consider taking the following proactive actions now.

Take Inventory

Take inventory of existing agreements and arrangements where vesting or payment is tied to compliance with — or a clawback obligation is tied to a breach of — noncompetition provisions. Consider how these agreements would be modified if the proposed rule becomes effective.

Section 280G

In the transactional context, when conducting a Section 280G analysis, consider the economics of the deal and the potential need to model alternative scenarios for a Section 280G shareholder vote if noncompetition provisions can no longer be used to mitigate the adverse tax treatment.

Enforceability

When entering new arrangements, keep in mind that you may not be able to enforce payments that hinge on employees complying with noncompetition provisions. Consider other alternatives, such as linking the compensation amount to how well the enterprise performs, which would indirectly discourage the post-termination employee from behaving in ways that could harm the company.

Alternate Protections

Tie the payment of compensation to compliance with nondisclosure, trade secret protections and narrowly tailored nonsolicit provisions, which the FTC indicates are not prohibited under the proposed rule.

Make sure that such provisions have a tight scope to reduce the risk of their being characterized as de facto noncompete provisions.

New Compensation Strategies 

Develop new compensation designs that would offer creative alternatives to compensating employees for complying with noncompetition provisions.

For example, European-style garden leave may become more popular, along with provisions that, though they don’t affirmatively prohibit competition, offer an incentive to former workers to avoid competitive activity. Still, these would also need to be carefully designed to avoid arguably functioning as noncompetes.

Right to Rescind

Reserve the right in new employment agreements or compensation arrangements to unilaterally rescind — to the extent permitted by law — payments and benefits given in consideration for a worker’s noncompete promise, in the event the noncompete is required to be rescinded.

Conclusion

The proposed rule will face significant pushback and legal challenges before it becomes final and effective — if it ever does — so employers should not rip up their noncompetes just yet. 

Still, prudent employers should start thinking of how their compensation and benefits arrangements might differ in a world without noncompetes.

Please contact a Jackson Lewis employee benefits team member or the Jackson Lewis attorney with whom you regularly work if you have questions or need assistance.

This article first appeared in Law360. 

[1] https://www.ftc.gov/system/files/ftc_gov/pdf/p201000noncompetenprm.pdf.

[2] Jackson Lewis recently published a detailed overview of this proposed rule

[3] See Treasury Regulation Section 1.83-3(c)(2).

The SECURE 2.0 Act of 2022 (the Act) contains several provisions that liberalize the rules for fixing particular retirement plan administrative mistakes that happen occasionally.  The IRS has a comprehensive program for correcting retirement plan failures, the Employee Plans Compliance Resolution System (EPCRS), including a self-correction program and a voluntary compliance program (VCP).  Most sponsors prefer to self-correct because the VCP filing can be time-consuming and costly, and sponsors must suffer the indignity of admitting their mistakes to the IRS.  Three provisions in the Act provide employers with some relief for fixing retirement plan mistakes. 

  1. Expansion of EPCRS – Eligible Inadvertent Failures.  The Act significantly expands the types of retirement plan failures that can be self-corrected.  Instead of identifying the types of failures that can be self-corrected, the Act provides that a retirement plan can self-correct for an “eligible inadvertent failure” (EIF) unless the IRS discovers the failure before the sponsor has demonstrated a specific commitment to self-correct it.  In other words, once the self-correction has started, it can be self-corrected even if the IRS discovers the failure before the employer completes the correction.  To take advantage of the new rule, the employer must correct the failure within a reasonable period.  Under the current EPCRS, the IRS defines a reasonable period as the last day of the third plan year after the plan year in which the error occurs, but the Act extends the deadline indefinitely unless the IRS discovers the failure before the sponsor begins the self-correction process.  The moral of the story is that if employers want to take advantage of the new liberal self-correction rules, they need to find the failure before the IRS does and start making the correction. 

To qualify for self-correction under the new rule, an employer must also have established practices and procedures reasonably designed to promote and facilitate overall compliance in form and operation with the Internal Revenue Code’s requirements.  In addition, self-correction is not available for egregious failures or failures involving diversion or misuse of plan assets or whose purpose is tax avoidance. 

Self-correction is also available for several specific types of failures. 

  • Participant Loan Failures.  The Act provides that EIFs related to participant loan failures can be self-corrected if the failure is corrected following existing EPCRS procedures for that type of failure.  The failure will also be considered corrected under the DOL’s separate correction procedures, subject to any reporting or procedural requirements the DOL may decide to impose. 
  • IRA Failures.  The Act expands self-correction to include failure where the employer is seeking a waiver of the excise tax associated with certain IRA failures and failures related to non-spouse beneficiaries’ distributions to inherited individual retirement plans as long as the beneficiary had reason to believe the funds could be rolled over without tax liability. 

The Act requires the Treasury Secretary to issue guidance regarding the correction of EIFs, including corrections for specific failures and general correction principles for failures for which there is no specific correction.   The Secretary must also revise EPCRS revenue procedure to reflect the above changes within two years. 

  1. Retroactive Amendments Increasing Benefits.  The Act also extends the deadline for amending plans to increase benefit accruals until the due date of the plan sponsor’s tax return (including extensions).  Under prior law, amendments not required by law to retain the plan’s qualified status had to be made by the last day of the plan year.  Under the new law, an employer could adopt an amendment that retroactively increases benefits to participants under the plan after the plan year is over but before the sponsor must file its tax return.  For a calendar year corporation with a filing extension, the deadline would be September 15th of the subsequent year.  This rule does not apply to matching contributions.  This provision will be helpful only to a small group of plan sponsors who want to increase benefits retroactively after the plan year ends.  This provision is effective for plan years beginning after December 31, 2023.   
  1. Safe Harbor Corrections for Employee Elective Deferral Failures.  The Act provides relief to plans with failures related to automatic enrollment or escalation features and plans that fail to offer an eligible participant an opportunity to make an affirmative deferral election because the plan improperly excluded them.  Under prior law, employers with these types of plan failures did not have to make up for missed employee elective deferrals if they made the corrections within a specified time period.  Still, that rule was set to expire on December 31, 2023.  The Act makes the relief permanent. 

To take advantage of the relief, a plan sponsor must correct the failure by the earlier of:

  • The date of the first payment of compensation to the employee on or after the last day of the nine-and-a-half month-period after the end of the plan year during which the error occurred; or
  • The first compensation payment date on or after the last day of the month following the month in which the employer receives notification of the error.

    The employer still must make up any matching contributions associated with the missed deferrals (plus earnings) but may forego making up for missed elective contributions.

    What Plan Sponsors Should Do.  To take advantage of the new law, plan sponsors should:

    • Identify and correct errors before the IRS discovers them – the race is on
    • Establish practices and procedures designed to promote and facilitate compliance with IRS requirements
    • Before filing a VCP application with the IRS, determine whether the failure qualifies for self-correction under the new law
    • If employers want to increase benefits for the prior year based on better-than-expected financial results, they have until the due date of their tax return to do so

    Please contact a Jackson Lewis employee benefits team member or the Jackson Lewis attorney with whom you regularly work if you have questions or need assistance. 

    Welcome to Part 8 of our series about the SECURE 2.0 Act of 2022 (SECURE 2.0) (our other articles may be found on our JL Employee Benefits Blog Post Page).  Among the many changes within SECURE 2.0 are two provisions that may help employers reduce the number of retirement plan accounts of terminated vested participants: (i) the retirement savings lost and found program and (ii) the increase in the threshold for mandatory plan distributions.  

    RETIREMENT SAVINGS LOST AND FOUND (Section 303)

    Section 303 of SECURE 2.0 requires the Department of Labor (DOL), in consultation with the Department of the Treasury, to create an online searchable lost and found database of retirement plans.  The database will enable plan participants, who might have lost track of their retirement plan, to search for the contact information of their plan administrator.  

    The deadline for the DOL to establish the database is December 29, 2024.  Under yet-to-be-drafted regulations, plan administrators must furnish the DOL with information about the plan and terminated plan participants for plan years beginning after December 31, 2023.

    UPDATING DOLLAR LIMIT FOR MANDATORY DISTRIBUTIONS (Section 304)

    Current law permits a retirement plan, without participant consent, to cash out a participant who had a distributable event if the participant’s account balance is $5,000 or less.  Section 304 of SECURE 2.0 increases to $7,000, the threshold at which plans may automatically cash out a participant, effective for distributions made after December 31, 2023.  This change is optional and may require a plan amendment.

    Before an employer chooses to raise the mandatory distribution limit on its retirement plan, it should consider how it might affect the fees of its service provider.  For example, raising the cash-out threshold may be appropriate if fees increase with an increase in plan assets or the number of plan accounts.  However, an increase in the threshold might not be warranted in certain fee arrangements, such as where the fee rate decreases as plan assets increase. 

    Please contact a Jackson Lewis employee benefits team member or the Jackson Lewis attorney with whom you regularly work if you have questions or need assistance.

    Additional Tools for Employers to Encourage Retirement Savings

    Matching Contributions on Student Debt Payments

    One of the most eagerly anticipated provisions of the “SECURE 2.0” legislation is the ability for employers to “match” within a defined contribution savings plan employees’ payments of student debt.   This provision is just one of the many changes in SECURE 2.0 aimed at enhancing and encouraging retirement savings opportunities for Americans.

    In 2018, the IRS issued a Private Letter Ruling (PLR) to Abbott Laboratories approving a proposed amendment to its 401(k) plan to allow a matching contribution based on student debt repayments rather than employee deferrals to the plan.  While binding only on the employer receiving it, the favorable ruling piqued interest in other employers looking for ways to recruit, retain and encourage retirement savings for an employee population that may not have otherwise deferred to the plan due to student debt obligations.  Over the past few years, that interest has grown for many employers looking at creative benefits solutions, but a clear, compliant, and universally available path forward was lacking until now.

    Under the new provisions of Internal Revenue Code Section 401(m)(4), any match must be based on student debt repayments for higher education expenses.  Eligibility, match rate, and vesting also must be the same as that for the match on elective deferrals.  The employee must annually certify that the loan payments have been made.  Employers may rely on this self-certification. 

    From an administrative perspective, it is significant to note that the statute anticipates possible issues for nondiscrimination testing of elective contributions.  A plan can test separately those employees who receive matching contributions on student loan repayments from those who receive matching contributions on elective deferrals.  The amount of loan repayments made by the employee count towards the annual limit on elective deferrals under Code Section 402(g) but not as a contribution for the limit on annual additions under Code Section 415(c).  These provisions of the Act have laid the framework to make the inclusion of such a provision less administratively burdensome.

    This is an optional provision that plan sponsors can implement in 401(k), 403(b), Governmental 457(b), and SIMPLE IRA plans for plan years beginning on and after January 1, 2024.  The IRS will issue implementing regulations and a model plan amendment for those plans wishing to adopt.

    But Wait, There’s More!  Financial Incentives

    In the same spirit of encouraging participation in defined contribution savings plans, SECURE 2.0 also allows employers to provide limited financial incentives to encourage participation in a 401(k) or 403(b) plan.  These incentives must be “de minimis,” although the statute does not define the threshold.  This likely means modest-value gift cards and other small incentives to encourage employees to participate, but notably, incentives may not be paid for with plan assets.  This tool is also optional and effective immediately, with no amendment to the plan required.

    If you have any questions about these new plan design opportunities or SECURE 2.0 generally, please contact a Jackson Lewis employee benefits team member or the Jackson Lewis attorney with whom you regularly work.

    The SECURE 2.0 Act of 2022 (SECURE 2.0) eliminates the requirement for plan sponsors to provide certain notices to eligible but unenrolled employees in defined contribution plans, changes the delivery method plan sponsors must use to furnish benefit statements to participants in retirement plans, and modifies the language required in annual funding notices under defined benefit plans.  It also requires agencies to perform significant studies on several notices and report their findings to Congress. 

    Before SECURE 2.0, plan sponsors of defined contribution plans were required to furnish eligible but unenrolled employees with all notices and other documents, such as summary plan descriptions (SPDs).  Effective for plan years beginning after December 31, 2022, plan sponsors no longer have to furnish unenrolled, eligible employees with notices as long as they provide the unenrolled, eligible employee an SPD and other notices upon their initial eligibility and then deliver an “annual reminder notice” advising of their eligibility to participate in the plan and any otherwise required document the unenrolled participant may request. 

    Generally, plan sponsors must provide benefit statements to participants in defined contribution plans every quarter and participants in defined benefit plans once every three years.  Effective after December 31, 2025, defined contribution plans must provide at least one benefit statement on paper in written form each year, and defined benefit plans must provide at least one benefit statement on paper in written form every three years.  Participants may elect to opt out of receiving the paper statement. 

    SECURE 2.0 adds another requirement to the 2002 e-delivery safe harbor:  effective for participants first eligible to participate in a retirement plan after December 31, 2025, plan sponsors must now provide a one-time initial paper notice of their right to request all required documents be furnished on paper in written form before the plan sponsor may begin furnishing benefits statements electronically under the safe harbor.  A plan may deliver a duplicate electronic statement in any situation where the plan furnishes a paper benefit statement.

    The annual funding notice, provided annually to defined benefit plan participants, is no longer required to disclose the plan’s “funding target attainment percentage” and will instead need to describe the plan’s “percentage of plan liabilities funded.” This change is effective for plan years beginning after December 31, 2023.

    Congress also demonstrated an interest in improving certain plan-related participant notices and disclosures by assigning these tasks:

    • The Government Accountability Office (GAO) will prepare a report analyzing the effectiveness of Internal Revenue Code §402(g) notices required to be provided by plan administrators of qualified plans to recipients of eligible rollover distributions, describing different distribution options and related tax treatment.  The GAO’s report must analyze the effectiveness of §402(g) notices and make recommendations, if needed, to enhance eligible rollover distribution recipients’ understanding of various distribution options, the tax consequences of each option, and spousal rights.  The GAO has 18 months to complete this task. 
    • The Department of Labor (DOL) must review its fiduciary disclosure requirements for participant-directed individual account plans.  They must explore potential improvements to the disclosure requirements that could enhance participant understanding of defined contribution plan fees and expenses and the impact of such fees and expenses over time.  The DOL will then report to Congress on their findings, including the advisability of potential consumer education around financial literacy concepts applicable to retirement plan fees and any recommended legislative changes needed to address those findings.  The DOL has three years to complete this task.
    • The DOL and Treasury (IRS) will adopt regulations permitting, but not requiring, the consolidation of certain retirement plan participant notices.  The participant notices eligible for consolidation include, among others, the §404(c)(5)(B) notice — concerning default investment arrangements under participant-directed individual account plans and the §514(e)(3) notice — concerning automatic contribution arrangements.  Any combined notice must still satisfy the requirements of all notices and may not obscure or fail to highlight the primary information required by each notice.  The DOL and IRS have two years to complete this task.                   

    If you have questions about SECURE 2.0, please contact a Jackson Lewis employee benefits team member or the Jackson Lewis attorney with whom you regularly work.

    Employees, especially those far from retirement, are sometimes hesitant to put money into their employer’s 401(k) plan, knowing that their money won’t be available to them if unexpected expenses arise. Congress and the Biden administration, recognizing the long-term benefit of incentivizing retirement savings, included two new means for plan participants to access emergency funds in the new “SECURE 2.0” legislation, which was signed into law at the end of last year.   We provide overviews of SECURE 2.0 here and here, and below discuss these new emergency distribution and Roth emergency savings account options. 

    Emergency Distributions

    Effective for plan years starting on or after January 1, 2024, 401(k) plans (along with 403(b) plans, 457(b) plans and IRAs) may allow participants to access up to $1,000 of their account balance (including pre-tax contributions) without penalty, in the event of an “unforeseeable or immediate financial needs relating to necessary personal or family emergency expenses.”  This new plan feature is modeled after certain other special in-service distribution options—namely, qualified birth/adoption distributions (QBADs) and the coronavirus-related distributions (CRDs) allowed under the CARES Act. Participants need only self-certify their need for the emergency distribution in order to request it. 

    Emergency distributions may be requested once per calendar year. However, a participant may not take another emergency distribution from the same plan or IRA within three years, unless the participant has already rolled their prior distribution back into the plan or IRA (as described below), or contributed to the same plan or IRA in an amount at least equal to their prior distribution.

    As with QBADs and CRDs, a participant who takes an emergency distribution can also roll the distribution back into the same plan or into an IRA within three years to avoid taxation on the distribution. If the amount is rolled back into a plan/IRA in a later year, however, it will require an amendment of the participant’s tax return for the year of the distribution.

    Roth Emergency Savings Accounts

    Also effective in 2024, plans may allow participants who are non-highly compensated employees (i.e., for 2024, those who earned less than $150,000 in 2023) to contribute up to $2,500 in post-tax deferrals to an emergency savings account under such plan, which will be treated as Roth contributions. Sponsors may even elect to set up automatic enrollment in this plan feature, with contributions of up to 3% of a participant’s pay until the contribution limit is hit, unless a participant affirmative opts out.

    Of note and likely key for both plan administration and investment communications – participants’ emergency savings account contributions must be invested in a manner that preserves capital – e.g., riskier investments that may be available under a plan, such as equity, aren’t allowed.

    Plan sponsors may not themselves contribute amounts to participants’ emergency savings accounts but are required (if their plan provides for matching contributions) to match any emergency savings account contributions by putting the corresponding match into the non-emergency savings account portion of the plan.  

    Participants may withdraw from the emergency savings account on at least a monthly basis, penalty free (though plans may charge a fee after the first four withdrawals per year). The legislation does, however, give plan sponsors some authority to prevent participants from using these accounts in a manner other than that intended by the SECURE 2.0 Act of 2022, by putting money into the emergency savings account, receiving the match, and then immediately withdrawing their own contributions. 

    When a participant with an emergency savings account balance terminates employment, a plan must allow for their balance to be (1) rolled into their plan Roth account (if applicable), (2) rolled into another plan or IRA, or (3) distributed to the participant. Since contributions to the emergency savings accounts are treated like Roth deferrals, any distribution (including earnings) will not be taxable to the participant. 

    ***

    While each of these new features are optional for plans, we do expect they will be implemented by many sponsors, and that they will be popular with potentially hesitant plan participants. 

    If you have questions about emergency distributions and/or savings accounts under SECURE 2.0, please contact a Jackson Lewis employee benefits team member or the Jackson Lewis attorney with whom you regularly work.

    The SECURE 2.0 Act of 2022 (SECURE 2.0) provides welcome relief to private sector single employer sponsors of defined benefit pension plans (Pension Plan(s)). Effective for plan years beginning on and after January 1, 2024, SECURE 2.0 caps the variable rate premium paid by Pension Plan sponsors to the Pension Benefit Guaranty Corporation (PBGC) at $52 per $1,000 or 5.2% of a Pension Plan’s unfunded, vested benefit liability. SECURE 2.0 does not change the flat rate premium also paid by Pension Plan sponsors and charged on a per participant basis.

    The purpose of the PBGC is to protect the vested benefit of Pension Plan participants if the Pension Plan in which they participate fails. The PBGC collects premiums from employers that sponsor Pension Plans to fund its responsibility. Because the PBGC is not funded by general tax revenue, it must heavily rely on the premiums paid by Pension Plan sponsors.

    Single employer sponsors of Pension Plans must pay two types of premiums to the PBGC: (i) a per participant flat rate premium ($96 for 2023) and (ii) a variable rate premium based on a percentage of a given Pension Plan’s unfunded, vested benefit liability. In addition, under the Bipartisan Budget Act of 2013, both the flat rate and variable rate premium became subject to inflation indexing tied to increases in wage growth.

    The change to index premiums has been widely criticized because the increased expense further discourages Pension Plan formation and encourages Pension Plan sponsors to terminate, freeze, or “de-risk” their Pension Plans partly to manage such ever increasing costs. In response to these criticisms and likely because the funded status of the single employer PBGC “insurance” fund has improved, Congress seized the opportunity to end the indexing of variable rate premiums. Note, however, Congress may increase the variable rate premium again, but to do so, it must amend SECURE 2.0. 

    We are available to help plan administrators understand and implement the requirements of SECURE 2.0. Please contact a Jackson Lewis employee benefits team member or the Jackson Lewis attorney with whom you regularly work if you have questions or need assistance.

    Most Americans prefer not to pay more in income tax than absolutely required or to pay taxes any sooner than necessary.  This includes many retired individuals who do not need to tap into their employer-sponsored retirement plan benefits yet but are required to do so – and to pay taxes on those benefits – once they attain a certain age.  The amount a retiree must take for a given year (and on which the retiree must pay taxes) is based on the value of the retiree’s account divided by the Internal Revenue Service’s applicable life expectancy table.  For retirees hoping to further postpone the year as of which they must begin taking retirement plan benefits, Division T of the SECURE 2.0 Act of 2022 (SECURE 2.0) delivered a holiday gift – one of several delivered by a bipartisan group of legislators in the Consolidated Appropriations Act of 2023.

    Before SECURE 2.0, a required minimum distribution (RMD) generally must begin by April 1st, following the year in which a retiree attains age 72.  This is the RMD beginning date set by the 2019 SECURE Act, effective for distributions after December 31, 2019.  Before that, retirement plan participants had to start taking RMDs from their retirement plans by April 1st after attaining age 70 ½.

    Effective for distributions made after December 31, 2022, Section 107 of SECURE 2.0 increases the RMD age to 73 for retirees who (a) attain age 72 after December 31, 2022, and (b) attain age 73 before January 1, 2033.  It then increases the RMD age to 75 for retirees who attain age 74 after December 31, 2032.

    Additionally, Congress directed the Internal Revenue Service to update its regulations to eliminate what can amount to a penalty on plan participants with accounts that include annuity contracts.  Under current regulations, if a retirement account holds an annuity contract in addition to other assets, the RMD amount is determined by bifurcating the account between the annuity portion and the other assets, with the result that RMD amounts can be higher than they otherwise would be if no part of the account value was attributable to an annuity contract.  Section 204 of SECURE 2.0 essentially provides that the plan participant can elect to have the RMD calculated based on the aggregated account.  Until new regulations are issued, plans can rely on a good faith interpretation of the law. 

    For RMD errors, Section 302 of SECURE 2.0 reduces the excise tax applicable when there’s a failure to take the full amount of an RMD timely.  Under prior law, the excise tax was equal to 50% of the amount by which a retiree’s RMD exceeded the amount actually distributed, if any, by the retiree’s required beginning date.  SECURE 2.0 reduces that excise tax penalty to 25% of the amount that should have been distributed.  (The penalty is further reduced to 10% if the retiree takes a corrective distribution within two years.) 

    Finally, under prior law, RMDs from a Roth IRA account did not have to begin before the account owner’s death, but no such exception to the RMD distribution rules existed for Roth accounts under employer plans, like 401(k) plans.  Section 325 of SECURE 2.0 ends the pre-death RMD requirement for Roth designated accounts in a 401(k) plan, effective for taxable years beginning after December 31, 2023.  However, note that, for retirees who attain age 73 in 2023, Roth account RMDs still must be made by April 1, 2024.     

    Stay tuned for more in our series on SECURE 2.0.  Please contact a Jackson Lewis employee benefits team member or the Jackson Lewis attorney with whom you regularly work if you have questions or need assistance.

    On December 29, 2022, President Biden signed the Consolidated Appropriations Act, 2023, and Division T of the Act contains legislation dubbed the SECURE 2.0 Act of 2022 (SECURE 2.0).  SECURE 2.0 contains an important provision regarding the eligibility of part-time employees to participate in an employer’s 401(k) plan or ERISA-governed 403(b) plan. The fundamental principle behind SECURE 2.0 is to make it easier for Americans to save for retirement, and this new provision will allow part-time workers who might previously have been excluded from participation to save for retirement just like their full-time counterparts.

    Long-Time Part-Time Workers Are Eligible

    The long-standing rule under ERISA Section 202 provides that an employee cannot be excluded from participation in a 401(k) plan beyond the later of the date the employee attains age 21 or completes one year of service. For this purpose, a year of service is defined as 1,000 hours of service during a 12-month period. 

    The SECURE Act (Setting Every Community Up for Retirement Enhancement) (enacted in 2019) provided that employees who perform 500 hours of service during three consecutive 12-month periods must also be permitted to participate in the employer’s 401(k) plan. 

    Section 125 of SECURE 2.0 requires that employees who work “two consecutive 12-month periods during each of which the employee has at least 500 hours of service” must be permitted to participate in the plan.  

    Special Considerations

    Exclusions: This rule does not apply to employees covered by a collective bargaining agreement, nonresident aliens who receive no earned income, or certain students.

    Eligibility Date: Once a part-time employee works the required hours for two consecutive years, the employee must be allowed to contribute to the plan by the earlier of the first day of the plan year after the date the employee satisfied the requirements or six months after the date the employee satisfied the requirements.

    Counting Hours Tips: Start counting hours on the date the employee’s employment commenced. If the employee does not complete the required hours of service during the initial 12-month period of employment, employers can then use the first day of the plan year for hours counting purposes going forward.

    Vesting Implications: ERISA’s vesting rules will correspondingly be updated by SECURE 2.0 to provide that employees who participate in the plan under this special rule shall be credited with a year of service for each year in which they perform 500 hours of service.

    Matching Contributions: Employers do not have to make nonelective or matching contributions for employees who become eligible to participate in the plan under this special rule.

    Nondiscrimination Testing: Employers may elect to exclude employees who become eligible to participate in the plan under this special rule for certain nondiscrimination testing purposes. 

    Effective Date

    This provision of SECURE 2.0 is effective for plan years beginning after December 31, 2024.

    Consider these examples: ABC Company sponsors the ABC Company 401(k) Plan, which is a calendar year plan. Jim is an employee of ABC Company, and Jim has been working 600 hours per year since 2019. Julia was hired on June 1, 2022, and works 900 hours per year. When should Jim and Julia become eligible to participate in ABC Company’s 401(k) plan?

    • Under the SECURE Act, ABC Company should have tracked Jim’s hours beginning on January 1, 2021, and after working 600 hours in 2021, 2022, and 2023, Jim would be eligible to participate in the ABC Company 401(k) Plan on January 1, 2024.
    • Under SECURE 2.0, 12-month periods beginning before January 1, 2023, shall not be considered.  Thus, if Julia works 900 hours in 2023 and 2024, she will become eligible to participate in the ABC Company 401(k) Plan on January 1, 2025.

    Careful Administration is Key

    Retirement saving plan eligibility for part-time employees is an area in which many employers inadvertently exclude eligible employees. As a result, the Internal Revenue Service has issued rules that govern correction where part-time employees are improperly excluded.

    If you have questions about the new rules for part-time workers under SECURE 2.0, or if your plan does not allow part-time employees to save for retirement, please contact a Jackson Lewis employee benefits team member or the Jackson Lewis attorney with whom you regularly work.

    The SECURE 2.0 Act of 2022 (SECURE 2.0) contains several provisions that allow the federal government to have its cake (more tax dollars) and eat it too (more retirement savings, easing Social Security challenges). With SECURE 2.0, we find more Roth, more catch-up, and catch-up as Roth. 

    More Roth

    Named after the late Delaware Senator William Roth, Roth IRA first became a savings opportunity in 1998.  Starting January 1, 2006, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) added this design feature to 401(k) plans. Although, for the most part, Roth deferrals are treated like pre-tax elective deferrals for plan purposes, they differ in two material respects: 

    1. Roth deferrals are subject to income taxation when contributed to the plan; and
    2. If all of the applicable requirements are met to comprise a “qualified distribution,” the earnings that accrue with respect to the Roth deferral will avoid taxation when distributed. 

    Roth elective deferral opportunities and in-plan Roth conversion and rollover opportunities have become relatively common plan features. They have the potential to create powerful savings tools, especially for those in lower income tax brackets. 

    Roth treatment historically has been limited to elective deferrals. That changed with SECURE 2.0.  Effective now (i.e., the date of enactment of SECURE 2.0), Section 402A of the tax code permits 401(k), 403(b), and governmental 457(b) plans to permit employees to elect to have employer matching or nonelective contributions treated as designated Roth contributions.  

    This avoids the need for participants to jump through the hoops of electing an in-plan Roth conversion with respect to these employer accounts, if permitted by the plan, to achieve this result. This also has the potential to produce marginal tax savings on the accumulated earnings if Roth treatment is elected at the time of contribution (rather than conversion).  

    Although immediately effective, employers interested in this opportunity likely will have to wait until payroll and recordkeeping systems are updated to accommodate this change.   

    More Catch-Up

    Those among us who are familiar with 457(b) plans and 403(b) plans know there are special catch-up contribution rules permitted in these plans that provide enhanced savings opportunities to those approaching retirement age. The concept is simple – let employees save more as they are preparing for retirement. 

    For example, Section 403(b) plans can allow employees who have at least 15 years of service to defer up to a lifetime maximum of $15,000 more into the plans than the customary 402(g) deferral limit of $22,500 in 2023. The annual amount is determined using a formula that takes into account years of service, prior elective deferrals, and prior Roth deferrals. 

    Likewise, 457(b) plans can allow special catch-up contributions during the 3 years immediately preceding normal retirement age. This allows eligible participants to double their deferral limit or contribute the annual limit plus the amount they did not contribute during prior years, whichever is less. 

    Section 109 of SECURE 2.0 brings this concept to 401(k) plans. Starting in 2025, participants who are age 60, 61, 62, and 63 will be subject to a higher catch-up contribution limit. In lieu of the standard Section 414(v) catch-up contribution limit applicable to those who are age 50 or older ($7,500 for 2023), these eligible participants approaching retirement may defer the greater of $10,000 (indexed) or 50% more than the regular catch up contribution limit. 

    For example, if, hypothetically, the regular catch-up contribution limit at the time is $9,000, and the indexed special catch-up contribution limit is $11,500, a 60-year-old participant could contribute $13,500 to the plan (the greater of $9,000 x 1.5 = $13,500 or $11,500). 

    Catch-Up as Roth

    So, what is the catch? Section 603 of SECURE 2.0 amends the catch-up contribution rules to require certain highly paid workers to contribute all of their catch-up contributions as Roth contributions starting in 2024. In many instances, this means the government will receive greater tax revenues on the same dollar because those who are actively working customarily are in a higher income tax bracket than they will be when drawing upon retirement savings. So, taxation is the cost of stockpiling retirement savings for these participants. 

    Who is highly paid for this purpose? We do not use the standard highly compensated employee definition for this purpose, which is $150,000 for 2023. Instead, we need to keep track of another dollar limit. This special rule applies to anyone earning more than $145,000 in FICA wages in the preceding year, which is subject to indexing in $5,000 increments. Highly paid participants who do not receive FICA wages (e.g., partners) are not currently captured by this rule, but this may be an oversight that is subject to change.

    So, back to our example, if the 60-year-old participant is earning more than $145,000 (indexed) in FICA wages when the higher catch-up contribution limit is in effect and wants to take advantage of deferring an additional $13,500 into the plan, that $13,500 will need to be a Roth contribution.  However, if this participant was earning $145,000 (indexed) or less, the $13,500 catch-up contribution could be made on a pre-tax basis.

    There are many questions about this change, and implementing guidance is needed. For example, are new hires or employees acquired in connection with a business transaction subject to this requirement in their first year of employment? What does the administrator do if the highly paid participant makes a pre-tax deferral election? For example, many plans process single deferral elections.  Once the regular deferral bucket fills, the deferrals are recharacterized as catch-up contributions. This administrative process will need to be revised, given this change in the law.       

    Note that offering only pre-tax catch-up contributions is not an option to avoid this complexity.  SECURE 2.0 specifies that if any participant would be subject to this Roth catch-up rule, the plan must offer a Roth catch-up contribution option in order for any participant (even those earning $145,000 or less) to make catch-up contributions to the plan. Congress designed this provision to ensure plans offer this Roth catch-up option.

    Participants also will have important financial and distribution planning questions to resolve. For example, if these catch-up contributions are the first Roth deferrals the individual makes, distribution planning will be needed to avoid taxation on the earnings that accumulate.  Distributions from Roth accounts are not treated as qualified distributions if amounts are distributed within a 5-year period of when the first Roth contribution was made to the plan (or another plan in the case of a rollover). 

    Participant communication will be key, and amendments are on the horizon. Stay tuned for more in our series on SECURE 2.0.

    Please contact a Jackson Lewis employee benefits team member or the Jackson Lewis attorney with whom you regularly work if you have questions or need assistance.