12 Key Elements in the IRS SECURE 2.0 'Grab Bag' Notice

On December 20, the IRS released the long-awaited SECURE 2.0 guidance (a/k/a the “Grab Bag”) in the form of Notice 2024-02.  The notice is 81 pages of Frequently Asked Questions (FAQs) on various SECURE 2.0 provisions. As expected, there was no guidance related to student loan matching, pension-linked emergency savings accounts, or long-term part-time employees.  There was, however, a lot of other relevant guidance.  The following is a summary of the key points of each area of guidance in Notice 2024-02.

Auto-enrollment Mandate. SECURE 2.0 generally requires a 401(k) component of a plan established after December 29, 2022, to enroll employees automatically no later than 2025.  The guidance on this provision clarifies the following:

• Establishment:  A 401(k) component is considered established on the date when plan terms providing for 401(k) deferrals are initially adopted, even if the effective date of the 401(k) feature is later.
• Merger of Plans: If a plan subject to the automatic enrollment mandate is merged with a 401(k) established prior to the enactment of SECURE 2.0 (known as a pre-enactment 401(k)), the ongoing plan generally will be subject to the automatic enrollment mandate unless the merger meets specific requirements, such as a merger within the section 410(b)(6)(C) transition period.
• Spinning Off Plans: Generally, a spinoff of a plan will not change whether the arrangement is subject to the automatic enrollment mandate.  If a pre-enactment 401(k) plan executes a spinoff, the spun-off plan will continue to be treated as a pre-enactment 401(k) plan.
• Application to 403(b) Plans: Section 403(b) plans are excepted from the automatic enrollment requirement if the plan was established before December 29, 2022, regardless of when the deferral feature is added.
• Application to Starter 401(k) Plans: The guidance confirms that the automatic enrollment mandate applies to Starter 401(k) plans and Safe Harbor 403(b) plans.

Small Business Tax Credits. SECURE 2.0 enhanced and added tax credits for new small business retirement plans.  The guidance on this provision includes:

• Separate Credits: The employer contributions credit under section 45E(f) is treated as a separate credit in addition to the startup costs credit under section 45E(a), so an eligible employer may be eligible for both the startup costs credit and an additional employer contributions credit.
• Establishment Date: For the employer contributions credit, an employer plan eligible for the credit is considered established on the date the plan becomes effective for the eligible employer.
• Change in Eligible Employer Status: Eligibility for the tax credits requires the employer to be eligible in the year of plan adoption and the year for which the credit is taken. Therefore, a reduction in the number of employees cannot make an employer eligible for credits if it was ineligible in its first year.
• Plans Effective Before 2023: The guidance confirms that an employer eligible for credits before December 31, 2022, can still be eligible for the increased startup costs credit and/or the employer contributions credit for taxable years beginning after December 31, 2022. The credit, however, is only available for any remaining time in the applicable 3-year credit period (for the startup credit) or 5-year credit period (for the employer contributions credit).
• Self-Employed Individuals: Individuals with earned income instead of wages (e.g., sole-proprietors and partners) can be considered for the employer contributions credit, even if they have earned income or remuneration in excess of the wage limitation. Thus, contributions to a sole proprietor with earned income of $250,000 could generate a tax credit; earned income is not limited to the $100,000 threshold that applies to wages of W-2 employees.
• Timing of Credit for Employer Contributions:  Employer contributions are taken into account for the employer contributions credit in the taxable year when a deduction under section 404(a) would apply.

Military Spouse Credit.  SECURE 2.0 also provided an additional tax credit (section 45AA) for certain employers that provide retirement benefits for military spouses. The guidance on this provision includes:

• Employer Eligibility and Timing: The employer can claim the section 45AA credit only for taxable years within the 3-year credit period during which the employer meets the eligibility requirements.
• Amendment of Plan: The credit can be claimed before the plan is amended to become an eligible defined contribution plan; the employer is eligible beginning with the taxable year that includes the effective date of the plan amendment.
• Participation Before 2023: An eligible small employer can claim the section 45AA credit for a military spouse whose 3-year credit period began during a taxable year beginning on or before December 29, 2022; the employer remains eligible for the credit for any taxable year beginning after December 29, 2022, that falls within the military spouse's 3-year credit period.

Financial Incentives for Participation. SECURE 2.0 authorized plan sponsors to provide “de minimis” financial incentives to employees who elect to participate in the plan.  The notice includes a number of pieces of helpful guidance:

• Limit on Value: A financial incentive qualifies as a de minimis financial incentive only if its value does not exceed $250.
• Only for Employees Not Participating: The exception for de minimis financial incentives applies only to employees without an existing election to defer.
• Continued Participation Requirement: A de minimis financial incentive is maintained even if provided in installments contingent on the employee's continued deferral. Example: A $100 incentive is provided at the time of enrollment and a $50 incentive is provided for each of the following three years ONLY if the participant is still deferring.
• Matching Contributions: Matching contributions cannot be considered de minimis financial incentives.
• Not Subject to Usual Contribution Rules: De minimis financial incentives are not treated as matching contributions and are not subject to the usual Code rules governing plan contributions, including qualification requirements under section 401(a) and deductibility timing rules under section 404(a).
• Tax Treatment for Employees: Employees receiving de minimis financial incentives are subject to the same tax, withholding and reporting requirements that apply to any other employer provided fringe benefits. For example, if the financial incentive is a gift card, then it is a cash equivalent and is therefore includible in income.

Increased SIMPLE Limits. SECURE 2.0 increased the deferral limits for SIMPLE IRAs and SIMPLE 401(k) plans in certain instances.  The guidance on this provision includes:

• Plans Eligible for Increased Limits: The increased limits apply only if the employer had not established or maintained a qualified plan, section 403(a) annuity plan, or section 403(b) plan for substantially the same employees in the 3- year period before maintaining the SIMPLE plan.
• Application Based on Employee Count: The increased limits apply automatically for eligible employers with up to 25 employees who received at least $5,000 of compensation in the preceding calendar year, and eligible employers with more than 25 such employees can choose to apply the increased limits by making an election.
• Employee Count: The rules from IRS Notice 98-4 apply for determining the number of employees who received at least $5,000 of compensation—meaning all employees and self-employed individuals are counted (regardless of eligibility).  A 2-year grace period is generally allowed for an employer that increases its employee count beyond 25.
• Reflecting Increased Limits: Employers making an election to apply increased limits must take formal written action and update plan terms accordingly. Employees must be notified of the increased limits.
• Election Deadline: An employer's election to apply increased limits must be made before providing the annual notice to employees.  The election remains effective until formally revoked (before the required annual notice is provided).

Terminal Illness Distributions. SECURE 2.0 also provided a new exception to the 10% additional tax on early distributions for individuals who are terminally ill.  The notice provides detailed guidance on this provision, including the following:

• Not a Separate Distribution Right: The Notice confirms that terminally ill individuals are not entitled to new distribution rights--the employee must be eligible for another permissible distribution from the plan. [Note that the technical corrections bill includes a provision to make this a distributable event.]
• Optional for Plans: Qualified retirement plans are not required to recognize terminally ill individual distributions when reporting the distribution. For example, if a terminally ill participant takes a hardship distribution from the plan, the plan may process the distribution and report no exception to the 10% tax.
• Recognition of Plan Distribution on Tax Form 1040: If a plan does not recognize terminally ill individual distributions, employees may treat an otherwise permissible in-service distribution as a terminally ill individual distribution on their tax return.
• Relevant Details: If a plan wants to recognize terminally ill individual distributions when reporting distributions from the plan, the Notice also provides the following relevant guidance:
  • Certification to Plan Administrator: The employee must provide the plan administrator with a physician's certification, meeting specified requirements, to qualify for a terminally ill individual distribution.  Plan administrators may not rely on self-certification from an employee; a physician's certification is required.
  • Definition: A terminally ill individual distribution is any distribution from a qualified retirement plan (including 401(a), 403(a), 403(b), and IRAs) to an employee certified by a physician as terminally ill.
  • Terminally Ill Individual: A terminally ill individual, for the purpose of this exception, is someone certified by a physician (generally a licensed doctor of medicine or osteopathy) to have an illness or condition expected to result in death within 84 months.
  • Physician Certification Requirement: The physician's certification must include statements about the individual's terminal illness, a narrative description of supporting evidence, physician information, examination/review dates, and the physician's signature with an attestation.
  • Distribution Timing: The distribution must be made on or after the date of the physician’s certification to qualify as a terminally ill individual distribution.
  • No Distribution Limit: Generally, there is no limit on the amount an employee may receive as a terminally ill individual distribution.
  • Recontribution Option: Employees may recontribute any portion of a terminally ill individual distribution to a qualified retirement plan, subject to rules similar to qualified birth or adoption distributions.

Mid-Year Termination of SIMPLE.  SECURE 2.0 provided employers an option to terminate a SIMPLE plan mid-year if a safe harbor 401(k) plan is adopted to replace the plan.  Guidance on this provision includes:

• Termination Process:  An employer terminates a SIMPLE IRA plan by formal written action specifying the termination date.  No salary reduction contributions are allowed for compensation paid after the termination date. The Employer must still make matching contributions based on compensation through the termination date.
• Notification Requirements: Employers must notify employees at least 30 days before termination, specifying the end of salary reduction contributions.
• Distribution Rollover: Distributions, even those within the first two years of participation, may be rolled over to a 401(k) or 403(b) plan.
• Exception of Other Plan Rule: Establishing a safe harbor plan is an exception to the rule prohibiting both a SIMPLE IRA plan and another plan in the same calendar year as long they are not active simultaneously.
• Deferral Limits: If a SIMPLE IRA plan is replaced by a safe harbor 401(k) plan mid-year, the total elective contributions must not exceed the weighted average of limits for each plan during the transition year.
• First Safe Harbor Notice:  The notice required for the transition year must describe the weighted contribution limit—it cannot simply reference the annual limit.

Cash Balance Plan Accrual Rule. SECURE 2.0 modified how a cash balance plan is tested for compliance with the accrual rule under Code Section 411.  Key points of the guidance include:

• Effect of Change: For cash balance plans with age or service-based pay credits and variable interest crediting rates, the enactment of section 348 removes the need for a fixed annual minimum interest crediting rate to comply with section 411(b)(1) of the Code.
• Permitted Amendments:  Amendments made “pursuant to” section 348 are subject to the timing of SECURE 2.0 amendments and also are entitled to 411(d)(6) anti-cutback relief.  Only certain amendments are treated as pursuant to section 348:
  • An amendment to change the interest crediting rate if the plan is currently providing for principal credits that increase with a participant’s age or service, or
  • An amendment to implement principal credits that increase with a participant’s age or service.
• Prohibited Amendments: Plans cannot reduce a participant's accumulated benefit determined as of the end of the interest crediting period that includes the amendment date.  So, amendments may apply prospectively, but cannot take away interest credits that have already accrued.
• Permitted Change is Restricted:  Only certain changes to the plan’s interest crediting rate may be made pursuant to section 348.  The change must meet the criteria set forth in the answer to question H-4 of the FAQs.

Self-Correction for Automatic Enrollment Arrangements.  Plans with automatic enrollment features were granted special correction relief.  Guidance on this relief includes:

• Effective Date: The provision is effective for errors where the date by which correct deferrals must be implemented is after December 31, 2023.  Correct deferrals must begin by the earlier of the date of the first payment of compensation after (1) the 9½-month period following the plan year with the error or, (2) if the employee reports the error, the second month after the month of notification.
• Correction Method: Eligible implementation errors can be corrected using the safe harbor correction method in Rev. Proc. 2021-30, Appendix A, section .05(8), for automatic contribution feature failures in a section 401(k) or section 403(b) plan.
• Terminated Employees:  The SECURE 2.0 provision allows correction for implementation errors, whether employees are active or terminated. The notice requirement clarifies that certain items in the required notice are not applicable for terminated employees.
• Deadline for Matching Contributions:  A corrective allocation of matching contributions, adjusted for earnings, must be made within a reasonable period after the correct amount of elective deferrals begin. If made by the last day of the sixth month following the month when correct deferrals begin, it is considered within a reasonable period. For automatic contribution errors before December 31, 2023, the correction deadline is the end of the third plan year after the error occurred.

Amendment Deadline.  The Notice provides additional relief related to the deadline to adopt amendments that related to SECURE 2.0.  The amendments apply to both required and discretionary plan changes.  The deadlines in the notice, which are extensions to the statutory deadline, include:

• Qualified Plans:
  • Non-governmental qualified plans must be amended by December 31, 2026.
  • Applicable collectively bargained plans have until December 31, 2028.
  • Governmental plans (section 414(d)) have until December 31, 2029.
• Section 403(b) Plans:
  • Non-public school 403(b) plans must be amended by December 31, 2026.
  • Applicable collectively bargained plans of tax-exempt organizations have until December 31, 2028.
  • Public school 403(b) plans have until December 31, 2029.
• Eligible Governmental Plans:
  • The deadline for eligible governmental plans is the later of December 31, 2029, or the first day of the first plan year beginning more than 180 days after the date of notification regarding inconsistent administration with section 457(b) of the Code.
• IRAs:
  • The deadline for amending the trust governing an IRA or the contract issued by an insurance company for an IRA is December 31, 2026, or a later date prescribed by the Secretary.
  • The deadline for amending deemed IRA provisions is the same as the deadline for the plan under which the deemed IRA is established.

Roth SIMPLE or SEP IRA.  SECURE 2.0 permitted an employee who participates in a SIMPLE IRA plan or simplified employee pension (SEP) arrangement to designate a Roth IRA as the IRA to which contributions under the plan or arrangement are made.  Guidance on this provision includes:

• Not Required: Employers are not obligated to offer employees a Roth contribution election.
• Timing of Roth Election:
  • For SIMPLE IRA plans, the election must be offered with the same effective opportunity as salary reduction agreements.
  • For Salary Reduction SEPs (SARSEPs), it follows the salary reduction agreement.
  • For SEPs without a SARSEP, an effective opportunity to make the election must be provided.
  • Roth IRA contributions must be elected before the contribution is made.
• Election Required: Employers cannot contribute to a Roth IRA without an employee's first making the Roth contribution election.
• Income Inclusion: Salary reduction contributions are included in the taxable year that would have included regular salary. Employer matching or nonelective contributions are included in the employee’s taxes in the year of contribution (which is usually not the year to which the contribution relates).
• Reporting: Salary reduction contributions reported on Form W-2 using Code F or S. Employer matching or nonelective contributions reported on Form 1099-R.
• Tax Withholding: Salary reduction contributions are subject to income tax withholding, FICA, and FUTA. Employer matching or nonelective contributions are excluded from wages for tax withholding purposes, FICA and FUTA.
• IRS Form Amendment: Employers can use existing forms until new guidance is issued.

Roth Employer Contributions: SECURE 2.0 added the ability of an employee to designate that employer matching contribution or nonelective contributions would be made to the plan on a Roth basis.  Guidance on this provision includes:

• Optional for Plans: The plan may adopt any aspect of a Roth contributions program without adopting the other.  Thus, an employee generally may be permitted to designate an elective contribution as a Roth contribution without being permitted to designate a matching contribution or nonelective contribution as a Roth contribution.
• Rules for Elections:  Rules similar to those for designated Roth elective contributions apply to designated Roth matching and nonelective contributions. Employees must make irrevocable designations, and separate accounting rules apply. Employees must have an effective opportunity to make or change designations at least once each plan year.
• Vesting: Employees cannot designate a matching or nonelective contribution as Roth if not fully vested in that type of contribution when allocated. The plan will not be considered to fail section 401(a)(4) because it allows designated Roth contributions only to those participants who are fully vested.
• Year of Inclusion in Gross Income: Designated Roth contributions are included in an individual's gross income for the year in which they are allocated to the account (which is usually not the year to which the contribution relates).
• Not FICA and FUTA Wages: Designated Roth matching and nonelective contributions are excluded from wages for federal income tax withholding, FICA, and FUTA purposes. For governmental 457(b) plans, however, the contributions may be subject to FICA (unless the employees are covered by a social security replacement plan).  
• Reporting: Designated Roth employer contributions will be reported in the same manner as if the contribution were directly rolled over to a designated Roth account (i.e., they are reported using IRS Form 1099-R and not Form W-2).
• Other Definitions of Compensation: Designated Roth contributions are not included in the 415 safe harbor definition of compensation.

This is intended to be a brief overview of the key items in Notice 2024-2. Look for more in-depth analysis in future publications, conferences, and webcasts.