401(k) plans may go through several changes if the bills known as the SECURE Act and RESA make it through Congress. The retirement savings legislation has cleared both the Senate Finance and the House Ways and Means Committees.
If passed, the bills would expand 401(k) coverage to long-term employees who work as few as 500 hours annually. Additional changes include a new penalty-free distribution for birth or adoption, support for auto-enrollment programs, and streamlined safe harbor rules.
The House bill is called Setting Every Community Up for Retirement Enhancement (SECURE) Bill of 2019 (HR 1994), and the identical Senate bill is called the Retirement Enhancement and Savings Act (RESA). Changes for IRAs were discussed in an earlier post.
401(k) Changes under New Retirement Savings Bills
These changes stand out for 401(k) plans:
- plans would have to include 3 year / 500-1000 hour per year employees;
- plans could allow qualified birth or adoption distributions that do not incur 10 percent early distribution tax;
- the maximum auto-enrollment contribution percentage would be increased;
- the non-elective contribution nondiscrimination safe-harbor would be streamlined.
New 3-Year / 500-1,000 Hour Per Year Track to 401(k) Participation
Under current law, employers that maintain a 401(k) plan are not required to offer it to part-time employees who work less than 1,000 hours per year. The rules require only that that employers offer the plan to any employee who has both attained age 21 and has completed at least one year of service. A “year of service” is defined as a 12-month period during which the employee has worked at least 1,000 hours. Someone who works a bare 1,000 hours would be averaging 19.2 hours per week.
The new law requires employers to offer employees who work between 500 and 1000 hours year a different track to 401(k) participation. Employers would have to have two eligibility requirements under which an employee must complete either:
- a one year of service requirement (with the 1,000-hour rule), or
- three consecutive years of service where the employee completes at least 500 hours of service.
Employers with collectively bargained plans are not subject to this requirement. Presumably, if the employees are represented by a union and wanted this kind of benefit, the union would negotiate for it.
Broader Effects on Employers
Nondiscrimination. Individuals who would qualify for participation under the 500 hour rule are likely to be low paid employees which could cause nondiscrimination headaches for the employer. However, the new law provides that for employees who are eligible solely by reason of working at least 500 hours for three consecutive years, the employer may elect to exclude such employees from testing under the nondiscrimination and coverage rules, and from the application of the top-heavy rules.
Spill over to other plans. The rule change would only affect 401(k) cash or deferral arrangements. It would not mandate a similar 500-1,000 hour track for other defined contribution plans such as profit sharing plans, 403(b) plans, or SEP plans. Of course, employers who adopt the 500-1,000 track for 401(k) plans might go ahead and do it for their other plans too.
Gendered participation disparity. In addition, as noted in the press release for the House bill, women are more likely than men to work part-time. So this rule change should reduce any 401(k) participation disparity based on full or part-time status.
Why Would 500-1,000 Hour Employees Want to Participate in a 401(k)?
What benefit would this change provide given that a part-time employee could already contribute to an IRA? There are several considerations:
- A 401(k) might include a match or nonelective payment by the employer so the employer can qualify for a nondiscrimination safe harbor. Although 500-1,000 hour employees would be excluded from nondiscrimination rules, the law change would not alter the general safe harbor requirements to exclude such employees from receiving matching or nonelective contributions.
- The 401(k) might include distributions from other defined contributions plans maintained by the employer. For example, many employers maintain profit sharing plans that distribute employer contributions to employee 401(k) accounts. Although an employer would not be required to include 500-1,000 hour employees in its profit sharing plan, an employer might not go to the bother of excluding such employees in practice.
- Lower paid employees would not be prevented from contributing to both an IRA and 401(k) since the phase out for deductible IRA contributions for those with retirement plans would not apply to them (spouses count too, so one would have to check this).
- Under existing law, an individual cannot contribute to an IRA starting in the year they attaining age 70 ½. Even under existing law, however, individuals who are still employees can contribute to their employer’s 401(k) plan.
- The required minimum distribution rules do not apply to non-owner employees until they cease employment. IRA owners, in contrast, have no choice but to start required minimum distributions the year they turn age 70 ½ (under existing law) or age 72 (if the new law passes).
401(k) Auto-Enrollment Safe Harbor Cap Raised and New Credit
One of the problems with the transition away from traditional defined benefit pension plans to a voluntary employee retirement savings program, such as 401(k)s, is that rank and file employees tend to under-save. One remedy that has been around since the 2006 Pension Protection Act is automatic enrollment. Under that system, the default position for employees is to set aside at least some retirement savings in their 401(k) account. They can always opt out, or change their contribution rates.
Under existing law, the deferral amount for the automatic enrollment safe harbor is capped at 10 percent of compensation. The new bills would raise that to 15 percent.
In addition, the new law would create a tax credit for small employers of up to $500 per year to employers to defray startup costs for new 401(k) plans and SIMPLE IRA plans that include automatic enrollment. The credit could also be available to employers that convert an existing plan to an automatic enrollment design.
401(k) Non-Elective Contribution Safe Harbor Made Easier
Employers must abide by nondiscrimination rules for their qualified retirement plans, including 401(k) plans. Employers must conduct testing, and be prepared to alter contributions if the plans do not pass rules designed to ensure that highly compensated employees do not benefit substantially more than other employees. That’s why employers like safe harbor plans, even if it requires them to make contributions.
The non-elective contribution safe harbor requires employers to contribute three percent of compensation to all non-highly compensated employees. The employer must notify its employees of their rights and obligations, and give them a chance to enroll. The regulations contemplate that an employer that elects to use this safe harbor will stick with it for the year. “Mid-year” changes in nonelective status can only be made in limited circumstances, and employees must be notified.
Notice and Status Amendments
The new law would eliminate the notice requirement. It would also allow amendments to nonelective status at any time before the 30th day before the close of the plan year. Amendments after that time would be allowed if the amendment provides:
- a nonelective contribution of at least four percent of compensation (rather than at least three percent) for all eligible employees for that plan year, and
- the plan is amended no later than the last day for distributing excess contributions for the plan year, that is, by the close of following plan year.
Qualified Birth or Adoption Distributions
Employers may offer penalty-free withdrawals from retirement plans for childbirth and adoptions of up to $5,000. Employees would have up to a year after the date of birth or adoption to take the distribution. IRA owners may take similar distributions penalty free from their IRA. Note that even though the 10 percent additional tax would not apply, the distribution amount would be taxed as income. Distributed amounts could be re-contributed back to the plan.
By James Solheim, J.D.