Fourth In A Series
As described in our previous articles (Changes and Opportunities for Retirement Plans, Broad Implications for Retirement Plans, and Provisions Unique to 403(b) Plans, Governmental 457(b) Plans, and IRAs), the Setting Every Community Up for Retirement Enhancement Act of 2019 (the “SECURE” Act) has broad implications for retirement plans. Although the Act’s primary focus is on defined contribution plans, several provisions of the Act and its sister legislation apply only to defined benefit plans.
This is the fourth in a series of articles describing key provisions of the legislation. Our emphasis in this article is on the provisions that are unique to defined benefit plans.
Earlier In-Service Withdrawal Age
The Further Consolidated Appropriations Act, 2020, which includes the SECURE Act, also includes the Bipartisan American Miners Act of 2019. This sister legislation amends Code Section 401(a)(36) to lower the age at which in-service withdrawals may be taken from defined benefit plans.
- Plans Affected: Defined benefit plans
- Optional or Required: Optional
- Effective Date: Plan years beginning on or after January 1, 2020
- Comments and Recommendations: Employers may now allow in-service withdrawals at age 59 ½ (rather than age 62). Employers choosing to add such an option (or to modify an existing provision) will need to revise participant communications, notices, and forms to reflect the appropriate information. In addition, employers must adopt a plan amendment in connection with implementing (or revising) this withdrawal option.
Increased Required Beginning Date Age
Prior to the passage of the SECURE Act, plans were required to begin making required minimum distributions (“RMDs”) by April 1 of the calendar year following the later of the calendar year in which an employee attained age 70 ½ or the calendar year in which the employee terminated employment. The Act amends Code Section 401(a)(9)(C) to increase this age to 72.
- Plans Affected: Defined benefit plans
- Optional or Required: Required
- Effective Date: Applies to individuals who reach age 70 ½ on or after January 1, 2020.
- Comments and Recommendations: An individual who attained 70 ½ prior to January 1, 2020, is required to begin RMDs under the prior rule. An individual who reaches age 70 ½ on or after January 1, 2020, however, is required to begin RMDs by April 1 of the calendar year following the later of the calendar year in which the employee attains age 72 or terminates employment.
The Tax Code also requires that if an employee continues to work after he or she attains age 70 ½, a defined benefit plan must provide for an actuarial increase to his or her accrued benefit for the period after age 70 ½ until the employee retires. The SECURE Act did not amend this portion of the Tax Code. Thus, the age at which a defined benefit plan must provide an actuarial increase remains 70 ½.
In connection with the RMD rules, employers should update participant communications, forms, and notices (including the special tax notice under Code Section 402(f)) to ensure that such materials accurately describe the new rules, and to ensure that distributions are treated appropriately for tax purposes. Plan amendments also must be adopted.
Nondiscrimination Testing and Participation Relief
As the cost of funding defined benefit plans has increased, many employers that sponsor such plans have taken action to limit future benefit accruals under them. Over time, however, these plans may find it difficult to satisfy the Tax Code’s nondiscrimination and minimum participation requirements. The SECURE Act offers relief from these testing requirements for certain closed or frozen defined benefit plans.
Employers that elect to limit future benefit accruals generally do so in one of two ways: (1) closing the plan to any new participants, so that participation is limited to a specific group of existing participants as of a specific date, who continue to accrue benefits (this is sometimes called a “soft freeze” or a “closed” plan); or (2) amending the plan to suspend any new benefit accruals for all participants (this is sometimes referred to as a “hard freeze” or “frozen” plan). Both soft-frozen and hard-frozen plans can experience compliance testing issues over time as the participant population becomes older or decreases in size. The SECURE Act provides nondiscrimination and participation testing relief for such plans, subject to specific requirements.
- Plans Affected: Defined benefit plans
- Optional or Required: Optional
- Effective Date: Immediate
Benefits, Rights, and Features
A soft-frozen defined benefit plan limits future benefit accruals to a select group of “grandfathered” employees. Over time, the composition of the group that continues to accrue benefits may shift, so that it consists of more highly compensated employees. As a result, it becomes more difficult for the plan to satisfy the Code Section 401(a)(4) benefits, rights, and features test. Under the SECURE Act, however, a defined benefit plan is deemed to pass this test if: (1) the plan satisfied these nondiscrimination requirements in the plan year that it was closed and the two subsequent plan years; (2) the plan is not later amended to significantly favor highly compensated employees (e.g., by modifying the closed class or changing the benefits, rights, and features available to them under the plan); and (3) the plan was closed before April 5, 2017, or the plan did not have a substantial increase in coverage or in the value of benefits during the five-year period before the closure date.
Benefit Accrual Basis
Employers that sponsor both a defined benefit plan and a defined contribution plan may aggregate those plans when performing nondiscrimination and coverage testing. Testing the aggregated plan as if it were a defined benefit plan (that is, on a “benefit accrual basis”) sometimes improves the chances of satisfying these tests. However, current regulations make it difficult to use this approach.
The SECURE Act allows an employer with a defined contribution plan and a closed or frozen defined benefit plan to aggregate the plans and test the aggregated plan on a benefits basis in some cases. The defined contribution plan generally must provide for contributions to make up (in part) for the loss of benefits the defined benefit plan participants expected to earn under the closed or frozen defined benefit plan. The defined benefit plan must; (1) provide benefits to a closed class of participants; (2) have passed the nondiscriminatory classification test for the plan year of the closure and the two subsequent plan years; and (3) not be amended later to significantly favor highly compensated employees. In addition, the defined benefit plan cannot have a substantial increase in coverage or in the value of benefits during the five-year period before the closure date, or must have been closed before April 5, 2017.
Minimum Participation
Closed or frozen defined benefit plans may also have difficulty satisfying the Code Section 401(a)(26) minimum participation requirements as participation in the plan decreases over time due to death or retirement. Under the SECURE Act, a plan is deemed to satisfy the minimum participation requirement if it: (1) is amended to freeze all benefit accruals, or provide future benefit accruals to only a closed class of participants; (2) satisfied the minimum participation test as of the effective date of the closure or benefit freeze; and (3) was closed before April 5, 2017, or did not have a substantial increase in coverage or in the value of benefits during the five-year period before the closure date.
The testing relief described above is already effective. Employers may elect to apply these provisions to plan years beginning on or after January 1, 2014.
Plan Amendments and Administrative Changes
While the impact of the SECURE Act on defined benefit plans is more limited than on other retirement plans, implementing the applicable changes – required and optional – can be complex.
Plans generally must be amended to include the mandatory SECURE Act changes by the end of the first plan year beginning on or after January 1, 2022. (For collectively bargained and governmental plans, the amendment deadline is January 1, 2024).
This blog post was drafted by Beth Miller, an attorney in the Spencer Fane LLP Overland Park, KS office. For more information, visit spencerfane.com.
