The Setting Every Community Up for Retirement Act (known as the SECURE Act) was signed into law by President Trump on December 20, 2019. This bill created changes to a number of rules related to Qualified Retirement Plans, including ESOP’s and 401(k). Some of the highlights of the bill include the following:
- Increases the deferral cap for automatic enrollment of participants from 10% to 15% of eligible wages.
- Adds a requirement to allow employees who are at least age 21, have worked for at least three consecutive 12-month periods, and have completed at least 500 hours of service in those periods to be able to make pre-tax salary deferral contributions to a 401(k) plan. As long as these employees stay under 1,000 hours per year, they can be excluded from employer contributions and certain nondiscrimination tests. Tracking of the three-year periods begins in 2021, so no employees will defer under these rules until 2024.
- Makes changes to the requirements to participate in a multiple employer plan.
- Pushes out the Required Beginning Date to receive Required Minimum Distributions from age 70 ½ to age 72. This is effective for anyone who has not already reached age 70 ½ by December 31, 2019.
- Eliminates the ability for most non-spouse beneficiaries to receive distributions over their life expectancy. Under the new rules distributions to most beneficiaries are limited to a 10 - year period.
- Eliminates the maximum age requirement (which was 70 ½) to make traditional IRA contributions.
- Eliminates the Safe Harbor Notice requirements for safe harbor plans with nonelective contributions only. However, Safe Harbor plans with matching contributions must still provide the required notices. Adds the ability to convert to a Non-Elective Safe Harbor plan up to 30 days before the plan year end if making a 3% contribution.
- Creates a new distribution event to allow a penalty-free withdrawal of up to $5,000 for expenses related to the birth or adoption of a child.
- Permits the adoption of new retirement plans up to the tax return due date of the employer, including extensions.
- Mandates that participant statements contain information about the lifetime income stream that would be provided by a participant’s current account balance. The disclosure will be made at least annually. Before the requirement can go into effect, the Department of Labor needs to provide guidance, including assumptions and model disclosures.
One other impact of the SECURE Act is a significant increase in IRS Penalties for Late Filing of Forms 5500 and 8955-SSA. For example, the penalty for late filing of Form 5500 increases from $25 a day to $250 a day, with a maximum penalty increased from $15,000 to $150,000.
The IRS Office of Chief Counsel released a Generic Legal Advice Memorandum (GLAM) on December 20, 2019. The purpose of this GLAM was to address Price Protection Agreements. Price Protection Agreements are sometimes put into place when an ESOP Company enters into a subsequent ESOP transaction that has a negative impact on the value of company stock. They are commonly used to ensure that certain participants who receive a distribution from the ESOP shortly after the subsequent transaction are paid out at a value that is determined without taking into account the impact of the debt incurred by the subsequent transaction. This is intended to “protect” the pre-transaction price for a specified period of time. The issue presented was specifically how the additional price-protected value can be distributed. Two distribution examples were covered in the GLAM.
The first example states that a distribution is made to the participant from the ESOP in the form of stock. The participant then puts (sells) the shares of stock back to the employer for payment. The employer redeems the stock from the participant at the price-protected value. It was the opinion of the Chief Counsel that the price-protection portion of the payment is not considered a qualified plan distribution. In this scenario the price-protected portion would then not be considered a distribution from the ESOP, which makes it ineligible for rollover treatment.
This first example would cause the price-protection portion of the payment to be a form of compensation. It would require the payment to be reported on Form W-2 rather than the 1099-R form generally used for qualified retirement plan distributions. It would also make the payment subject to typical payroll tax withholding. (Note that there is some push back in the legal community on this IRS example, as some believe the price-protected differential should be reported as another form of income rather than W-2 earnings.)
The second example stated that the employer would make an additional qualified non-elective contribution to the ESOP specifically for the additional price protected value to be allocated to those specific participants who have requested a distribution. That would allow that additional contribution to be distributed along with the participants remaining ESOP account balance. Chief Counsel ruled in this situation that the entire distribution would be qualified and therefore eligible for rollover treatment.
However, in the second example if an employer makes a special contribution to the ESOP for Price Protection purposes, it would make that contribution subject to the IRC Section 415 annual additions limitations. That limits contributions to the lesser of $56,000 (as indexed for inflation) or 100% of a participant’s compensation. In the event former employees request a distribution, their compensation is usually zero. Therefore, it would not be a feasible approach to make a qualified non-elective contribution to the account of a former participant with no wages for the purpose of a price protection feature.
These positions taken in the GLAM will make it administratively more cumbersome to process the price-protected portion of a distribution from an ESOP that has a price-protection arrangement in place. If you currently have a price-protection feature in place, please make sure to discuss this with your Blue Ridge ESOP Associates contact to ensure that future price-protection payments are handled properly.