The Road Ahead – Qualified Retirement Plan Amendments and More

The frequency of Congressional changes to the Internal Revenue Code affecting Qualified Retirement Plans (ie, pension plans, profit-sharing plans, 401(k) plans and employee stock ownership plans or ESOPs) has proven, over time, not to be linear. On occasion, several significant laws are passed in a relatively short period of time. In other years, there is no legislation affecting Qualified Retirement Plans, or any legislation passed which has an impact on the operation of a Qualified Retirement Plan.

For example, from 1982 to 1984, Congress passed the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), the Deficit Reduction Act of 1984 (DEFRA) and the Retirement Equity Act of 1984 (REA) – three Acts that contained significant changes affecting Qualified Retirement Plans.

Fast forwarding to more recent times – from late 2019 to late 2022 – Congress passed three legislative Acts that cumulatively had a significant effect on the operation of Qualified Retirement Plans.

The three are:

• the Setting Every Community Up for Retirement Enhancement Act, passed in late 2019 (the “SECURE Act”);
• the Coronavirus Aid, Relief and Economic Security Act, passed in spring of 2020 (the “CARES Act”); and
• the SECURE 2.0, passed in December of 2022. 

In this article, these three Acts will be referred to as “the Acts”.

After the passage of the SECURE Act and CARES Act, the best thinking was that Qualified Retirement Plans would have to adopt amendments to include the provisions of these Acts by the end of 2022. 

The difficulty in providing timely guidance, as well as the imminent passage of SECURE 2.0, resulted in the IRS extending the deadline for SECURE Act and CARES Act amendments until December 31, 2025. 

In an attempt to align the timing of the adoption of all required amendments, SECURE 2.0 also contains a December 31, 2025, amendment deadline (or, if later, the last day of the first plan year beginning on or after January 1, 2025). The deadlines apply to pre-approved prototype plans and individually designed plans.

Notethat terminating Qualified Retirement Plans do not have an extended remedial amendment period for the adoption of Act amendments. A terminating Qualified Retirement Plan must adopt amendments satisfying all relevant qualification requirements of the Acts effective on the date of termination. A terminating Qualified Retirement Plan should also amend, for any discretionary Acts, provisions implemented prior to termination.

Some provisions of the Acts were effective in 2020 (such as the change in the Minimum Required Distribution rules), and other provisions are effective in the years leading up to, and including, 2025.

The deferral of the plan amendment deadline presents an operational challenge for Qualified Retirement Plan sponsors.

With the deferred December 31, 2025, amendment date, plan sponsors must comply in operation with mandatory provisions of the Acts and consider discretionary provisions in the interim. In other words, plan sponsors need to ensure that their plans are being operated in accordance with the provisions that are relevant (both mandatory and discretionary), even if the plan document has not been amended to include the new provisions.

Individually designed plans have the discretion to adopt good-faith amendments prior to 2025.

Some individually designed plans have adopted interim amendments in an attempt to align plan operation with the plan documents. Sponsors of Qualified Retirement Plans using pre-approved prototype documents need to periodically check with the prototype provider regarding the status of good-faith interim amendments.

It is not possible to discuss all the changes contained within the Acts in this article – SECURE 2.0 alone contains more than 40 provisions that could result in a plan amendment (either mandatory or discretionary). It is fair to say that Qualified Retirement Plan sponsors and their advisors will spend many hours in the next couple of years reviewing the mandatory and discretionary provisions of the Acts and determining how to implement and comply with these new provisions.

Having said that, there are two SECURE 2.0 provisions that are timely and should be of interest to most Qualified Retirement Plan sponsors.

One provision is discretionary (Qualified Disaster Recovery Distribution), and one is mandatory (Mandatory Roth Catch-up Contributions for Highly Compensated Employees).

Qualified Disaster Recovery Distribution

The president has the authority, under the Robert T Stafford Disaster Relief and Emergency Assistance Act, to declare a “major disaster” for any natural event that the president determines has caused damage of such severity that it is beyond the combined capabilities of state and local governments to respond. Examples of events that in the past have been declared major disasters include hurricanes, tornados, storms, high water, wind-driven water, tidal waves, tsunamis, earthquakes, volcanic eruptions, landslides, mudslides, snowstorms or drought (regardless of cause), fires, floods or explosions.

Over two dozen major disasters have been declared to date in 2023. These major disasters affect plan sponsors and participants. Those living in Florida have learnt how disruptive a major disaster can be. For many individuals, assets in a Qualified Retirement Plan are an important source of funds to replace lost wages and begin the rebuilding process. For some participants, Qualified Retirement Plan assets are a primary source of funds.

Historically, not all Qualified Retirement Plans have allowed for an active participant to withdraw amounts following a major disaster. 

Even if a participant was able to withdraw amounts, the distribution would be subject to income taxes and, potentially, a 10% early distribution tax.

The Internal Revenue Code generally imposes the 10% early distribution tax on amounts withdrawn from a Qualified Retirement Plan prior to age 59 and a half, unless an exception to the early distribution tax exists. Examples of an exception to the 10% early distribution tax include disability or death of the participant.

SECURE 2.0 made an exception to the 10% early distribution tax permanent for individuals receiving a “Qualified Disaster Recovery Distribution” from a Qualified Retirement Plan, although the distribution still remains subject to income taxes. 

For a Qualified Retirement Plan distribution to qualify as a Qualified Disaster Recovery Distribution, the following requirements must be satisfied:

• the Qualified Disaster Recovery Distribution must be made during the period that begins on the first day of the “Incident Period” (which is specified by the Federal Emergency Management Agency (FEMA) as the period during which such disaster occurred) and ends before the date that is 180 days after the “Applicable Date” with respect to such disaster;
• the distribution must be made to an individual whose principal place of abode (ie, main residence) is located, at any time during the Incident Period, in the area with respect to which the major disaster was declared;
• such individual has sustained an economic loss by reason of such qualified disaster; and
• the aggregate amount of distributions received by an individual which may be treated as Qualified Disaster Recovery Distributions with respect to any qualified disaster in all taxable years cannot exceed USD22,000. 

If the Qualified Disaster Recovery Distributions for an individual exceed USD22,000, the Qualified Retirement Plan could have issues. All members of a controlled group are treated as one employer for the purposes of determining if the USD22,000 Qualified Disaster Recovery Distribution amount has been exceeded.

In addition to the avoidance of the 10% early distribution tax, there are additional options available to the participant which make Qualified Disaster Recovery Distributions attractive:

• Any individual who receives a Qualified Disaster Recovery Distribution may, at any time during the three-year period beginning on the day after the date on which such distribution was received, make one or more contributions to an eligible retirement plan of which such individual is a beneficiary. Naturally, aggregate contributions to an eligible retirement plan cannot exceed the amount of such Qualified Disaster Recovery Distribution received.
• In the case of any Qualified Disaster Recovery Distribution, unless the taxpayer elects otherwise, the taxable amount received is generally included in such individual’s gross income ratably over the three-year taxable period beginning with the year of receipt. This provision will be somewhat familiar to those who dealt with COVID distributions. The “spreading” of income across tax years provides an additional cushion to an individual who has incurred expenses during a national disaster.

Note that Qualified Disaster Recovery Distributions are not allowed for defined benefit pension plans or cash balance pension plans.

As mentioned above, amending a Qualified Retirement Plan to allow for Qualified Disaster Recovery Distributions is discretionary. The plan sponsor is not required to amend to allow for Qualified Disaster Recovery Distributions.

If a plan sponsor decides to allow for Qualified Disaster Recovery Distributions, the sponsor should consult with plan advisors to determine the best way to memorialize this operational change, implement this feature and administer the distributions. 

On a related note, Secure 2.0 also allows for a plan sponsor to elect to increase the limits on loans taken from a defined contribution plan to the lesser of: (i) USD100,000, or (ii) 100% of the participant’s vested account balance, if the following conditions are met:

• the loan is taken by a participant who lives in a major disaster area;
• the participant suffers an economic loss as a result of such major disaster; and
• the participant receives the loan within 180 days after the disaster.

The SECURE 2.0 provisions discussed above relating to Qualified Disaster Recovery Distributions are effective for national disasters occurring on or after January 26, 2021.

Mandatory Roth Catch-Up Contributions for Highly Compensated Employees

The second SECURE 2.0 provision relates to 401(k) “Catch-Up Contributions”. 

Most 401(k) plans allow participants who are age 50 or older to make annual Catch-Up Contributions. The maximum annual Catch-Up Contribution for 2023 is USD7,500. This maximum is adjusted annually for inflation. The Catch-Up Contribution is available for a participant once they reach the maximum annual deferral amount or are otherwise limited in making additional deferral contributions by the plan’s ADP test.

Prior to SECURE 2.0, each participant could elect to contribute the Catch-Up Contribution on a pre-tax basis or on an after-tax or Roth basis.

SECURE 2.0 made a change to the nature of the Catch-Up Contributions for certain participants.

Under SECURE 2.0, if  a person is eligible to make a Catch-Up Contribution and earned USD145,000 or more in the previous year, any Catch-Up Contributions would have to be made on a Roth after-tax basis.

The Roth Catch-Up Contribution change was scheduled to be effective beginning in 2024. When the retirement benefit community (qualified retirement plan sponsors, third-party administrators, legal counsel, actuaries and consultants) began to examine this new requirement, there were several items of concern.

• First, SECURE 2.0 did not clarify all relevant points regarding the implementation of the Roth Catch-Up Contributions, and left some operational questions unanswered. SECURE 2.0 was enacted in late 2022, and this late date left the IRS with little time to issue administrative guidance to address these questions.
• Second, for many Qualified Retirement Plan sponsors, new payroll systems and administrative changes were needed to comply with this requirement.  Many employers and payroll companies believed that these changes could not be accomplished by 2024.

On Friday, August 25, 2023, the IRS granted a two-year reprieve for the requirement that Catch-Up Contributions made by participants earning USD145,000 or more be treated as Roth deferrals. January 1, 2026 is the new effective date for compliance with the SECURE 2.0 Roth Catch-Up Contribution rules.

The IRS accomplished the reprieve by stating that the first two taxable years beginning after December 31, 2023, will be regarded as an administrative transition period. More specifically, a 401(k) plan will be deemed in compliance with the SECURE 2.0 Roth Catch-Up Contribution rules during this two-year period, even if Catch-Up Contributions made by participants earning USD145,000 or more are not designated as Roth contributions.

The IRS also stated that a plan that does not provide for designated Roth contributions will not be required to add Roth contributions during this period (this point was not clear prior to this IRS guidance).

The two-year reprieve will allow plan sponsors and advisors to prepare for implementation in 2026.

In conclusion, as stated above, the Acts collectively contain significant changes to the laws regulating Qualified Retirement Plans. Plan sponsors should use the period leading up to the December 31, 2025 amendment deadline to plan for the integration of the Acts’ provisions into the sponsor’s Qualified Retirement Plan, and take advantage of the resources available to determine what, if any, discretionary provisions to adopt.