SECURE 2.0 Act of 2022: Enhanced Retirement Plan Participation Provisions

The SECURE 2.0 Act of 2022 makes far-ranging changes to the US employer-retirement plan system. This LawFlash—one in a series—more closely examines the act’s provisions that expand and encourage retirement plan participation.

Since as far back as the Pension Protection Act of 2006, Congress has sought to make it easier and more attractive for employers to adopt provisions that encourage employee enrollment and participation in defined contribution plans (e.g., 401(k), 403(b) and governmental 457(b) plans), particularly through automatic enrollment features. SECURE Act 2.0 continues this push.

In particular, SECURE 2.0 Act of 2022 (SECURE Act 2.0) requires automatic enrollment in certain new plans, enhances the coverage requirement of long-term part-time employees, and permits employers to provide de minimis financial incentives to employees to encourage participation.

REQUIRED AUTOMATIC ENROLLMENT AND ESCALATION FOR NEW 401(K) AND 403(B) PLANS

Over the past 15 years, automatic enrollment features have become very common, and many employers have added or enhanced their plan’s existing automatic enrollment features (e.g., by including an automatic escalation feature). Until now, an employer's decision to add or enhance an automatic enrollment feature was voluntary. This is no longer the case for a newly established plan.

With a few exceptions as described below, SECURE Act 2.0 requires that a 401(k) plan or 403(b) plan that is newly established on or after December 29, 2022, the date of enactment of SECURE Act 2.0 (a New Plan), must satisfy certain automatic enrollment and automatic escalator requirements starting with plan years that begin after December 31, 2024. This means that for plan years beginning after December 31, 2024, a New Plan—even a New Plan established between December 29, 2022, and December 31, 2024—must satisfy the automatic enrollment and escalator requirements of SECURE Act 2.0. Similarly, any employer that first adopts a multiple-employer plan on or after December 29, 2022 will be treated as if the employer had adopted a New Plan.

There are a few exceptions to the SECURE Act 2.0’s mandatory automatic enrollment and escalator requirements for New Plans. Most importantly, the mandatory rules do not apply to 401(k) and 403(b) plans in existence before December 29, 2022. In addition, the mandatory automatic enrollment rules do not apply to governmental plans, church plans, or SIMPLE 401(k) plans. The mandatory rules also do not apply to plans sponsored by certain new and small businesses. More specifically, the rules do not apply to a plan during the first three years of an employer's existence and do not apply to small businesses until one year after the end of the first taxable year in which the employer normally employs more than 10 employees.

The mandatory automatic enrollment and escalator requirements that a New Plan must satisfy are as follows:

• The New Plan must include an automatic enrollment feature with a uniform automatic enrollment percentage of at least 3% but no more than 10% for an employee’s first year of plan participation.
• The New Plan must include an automatic escalator feature that increases the contribution percentage automatically by 1% on the first day of each plan thereafter until the participant’s contribution reaches at least 10% but no more than 15%. However, non-safe-harbor plans may not exceed 10% for plan years beginning before January 1, 2025.
• The New Plan must permit employees to withdraw amounts (plus earnings) that were automatically contributed to the plan within 90 days of the date such amounts were first contributed. As they were before SECURE Act 2.0, these withdrawals continue to be exempt from the 10% penalty tax on early distributions.
  • Observation: The withdrawal right is not surprising, as it is a hallmark of the special type of automatic enrollment arrangement called an “eligible automatic contribution arrangement” (EACA), which was established under the Pension Protection Act of 2006. In fact, SECURE Act 2.0 designates the New Plan required automatic enrollment arrangement as an “EACA,” as modified by the new statutory requirements.
• Amounts automatically contributed to the New Plan must be invested according to the rules governing qualified default investment alternatives (QDIAs) (e.g., defaulted into a target retirement date fund that is a qualifying QDIA, etc.).
  • Observation: While sponsors of existing retirement plans are not directly impacted by these rules, even existing plan sponsors may need to consider these rules in certain contexts (e.g., corporate transactions involving New Plans). Moreover, as noted, New Plans established between December 29, 2022, and January 1, 2025, must comply with these requirements beginning with their first plan year that begins on or after January 1, 2025. Due to this inevitability, and to simplify administration, a New Plan sponsor may want to implement the SECURE Act 2.0 automatic enrollment immediately rather than delaying implementation until after December 31, 2024.

EXPANDED COVERAGE OF LONG-TERM PART-TIME EMPLOYEES

SECURE Act 2.0 makes a number of significant changes to the long-term part-time employee rules that originally were established in the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act 1.0). Notably, SECURE Act 2.0 shortens the eligibility period for long-term part-time employees from three years to two years, includes analogous rules in the Employee Retirement Income Security Act of 1974 (ERISA), and applies the changes to ERISA-covered 403(b) plans for the first time.

To understand these changes, it's helpful to understand the original rules as established under SECURE Act 1.0. In particular, SECURE Act 1.0 required 401(k) plans to extend participation to any employee who completes at least 500 hours of service during each of three consecutive 12-month periods (Long-Term Part-Time Employee) for purposes of making elective deferrals to the plan. Only periods of service beginning on and after January 1, 2021 must be counted (which means that the earliest date a Long-Term Part-Time Employee would be eligible for participation under SECURE Act 1.0 is January 1, 2024). While SECURE Act 1.0 requires plan sponsors to allow Long-Term Part-Time Employees to make elective deferrals, a plan sponsor is not required to make matching or nonelective contributions to such employees. Further, the SECURE Act 1.0 Long-Term Part-Time Employee provisions do not apply to 403(b) plans or to collectively bargained employees for whom retirement benefits are the subject of good faith bargaining.

SECURE Act 2.0 changes and expands the SECURE 1.0 Long-Term Part-Time Employee rules in a number of significant ways:

• Establishes Shorter Two-Year Eligibility Period – Effective for plan years beginning after December 31, 2024, Long-Term Part-Time Employees who complete at least 500 hours of service in each of two consecutive 12-month periods must be eligible to make elective deferrals.
• Adds the Eligibility Rule to ERISA – The Long-Term Part-Time Employee eligibility rules are added as enforceable rights under ERISA. Before this change, Long-Term Part-Time Employees had no enforceable right to participate in a retirement plan, and the eligibility rules were only a tax qualification requirement. After this change, Long-Term Part-Time Employees are able to enforce their right to participate in a retirement plan through ERISA. This change also has implications for 403(b) plans as addressed in the next point. Importantly, for purposes of applying these rules under ERISA, an employee's service before 2023 is disregarded.
• Applies Eligibility Rules to ERISA-Covered 403(b) Plans – 403(b) plans that are subject to ERISA are now subject to the SECURE Act 2.0 Long-Term Part-Time Employee eligibility rules (but not the SECURE Act 1.0 requirements), meaning that service counting must begin in 2023 and the earliest date a Long-Term Part-Time employee can defer is for plan years beginning on or after January 1, 2025.
• Clarifies the Counting of Vesting Service for 401(k) Plans – Only service on and after January 1, 2021 must be counted for purposes of counting vesting service under a 401(k) plan for Long-Term Part-Time Employees. Under both SECURE Act 1.0 and 2.0, Long-Term Part-Time Employees must be credited with vesting service for 12-month periods in which they work at least 500 hours. However, as interpreted by the IRS, SECURE Act 1.0 provided that all of a Long-Term Part-Time Employee's service (even pre-2021 service) must be counted for vesting purposes. This IRS interpretation created an anomaly, as pre-2021 service was disregarded for eligibility purposes. SECURE Act 2.0 corrects this anomaly and confirms that pre-2021 service is disregarded for both eligibility and vesting purposes.

The SECURE Act 2.0 changes generally are effective for plan years beginning after December 31, 2024. However, the clarifying update to exclude pre-2021 service for vesting purposes is effective as if it was included in SECURE Act 1.0.

Observation: Although SECURE Act 2.0 generally is effective for plan years beginning after December 31, 2024, 401(k) plan sponsors must continue to comply with existing Long-Term Part-Time Employee rules established by SECURE Act 1.0. By way of example, a Long-Term Part-Time Employee who satisfies the three-year eligibility rule in SECURE Act 1.0 (i.e., the employee works at least 500 hours of service in three consecutive years—2021, 2022, and 2023) would be eligible to start making elective deferrals to the employer's 401(k) plan as of January 1, 2024.

Observation: Although 403(b) plans have a universal availability requirement—meaning that, in general, all employees must be eligible to make deferrals—sponsors have been able to design 403(b) plans to exclude employees who normally work less than 20 hours per week and employees who are students enrolled and regularly attending classes. After SECURE Act 2.0 and the amendments to ERISA and the Internal Revenue Code, 403(b) Plans are prohibited from excluding for deferral purposes any employees who are Long-Term Part-Time Employees. As a consequence, for plan years beginning on or after January 1, 2025, both student employees and employees who normally work less than 20 hours per week are required to be afforded a deferral opportunity under their employer’s 403(b) plan after two consecutive years of 500 hours or more of service.

ALLOWANCE OF DE MINIMIS INCENTIVES TO IMPROVE PARTICIPATION

Effective for plan years beginning after December 29, 2022, SECURE Act 2.0 permits a 401(k) or 403(b) plan sponsor to offer de minimis financial incentives to employees to encourage plan participation. Before SECURE Act 2.0, even de minimis financial incentives were prohibited under the "contingent benefit rule" that prohibits employers from offering any benefit that is conditioned on an employee's election to defer (or not defer) amounts to a plan (other than matching contributions or certain limited exceptions). De minimis financial incentives also raised potential prohibited transaction concerns under the Internal Revenue Code and ERISA. SECURE Act 2.0 creates explicit exemptions and exceptions to these rules so as to permit plan sponsors to provide de minimis financial incentives to employees to encourage plan participation. However, these de minimis financial incentives may not be funded by plan assets.

Observation: SECURE Act 2.0 does not include any specific examples, but such de minimis financial incentives might include things such as low-dollar gift cards, water bottles, or other similarly modest incentives.

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