SECURE Act - What provisions are unique to defined benefits plans?

This is the final article in a series describing key provisions of the SECURE Act, with a focus on provisions unique to defined benefit plans. With the recent enactment of the CARES Act that President Trump signed into law on March 27, 2020, it is understandable that employers are not focused on the numerous changes implemented by the SECURE Act.

However, some of its more immediate changes require employers to modify certain aspects of plan administration (and potentially financial planning decisions) to align with the Act’s requirements.

Some of the changes under the SECURE Act became effective immediately on December 20, 2019, while others became effective in plan or tax years beginning on or after January 1, 2020.  The Act provides for a remedial plan amendment period that does not end until the last day of the 2022 plan year (the 2024 plan year for governmental plans).  Therefore, employers generally have sufficient time to amend plan documents to comply with any required or optional changes. And they need to understand these changes to prepare themselves for the resulting effects.

Here are provisions in the Act that are unique to defined benefit plans.

1. 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. Specifically, employers may now allow in-service withdrawals at age 59½ (rather than age 62).

This is an optional change that employers can implement for plan years beginning on or after January 1, 2020. Employers choosing to add such an option or to modify an existing plan 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.

2. Increased age for beginning required minimum distributions

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 70½ 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 —  a required change.

The increase in the required beginning date age applies to individuals who reach age 70½ on or after January 1, 2020.

An individual who attained 70½ 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.  (It is worth noting that while the CARES Act provides a waiver for RMDs that otherwise are due in 2020, the waiver applies only to defined contribution plans.  The waiver does not apply to defined benefit plans.)

The Tax Code also requires that if an employee continues to work after he or she attains age 70½, a defined benefit plan must provide for an actuarial increase to his or her accrued benefit for the period after age 70½ 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 70½.

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.

3. Nondiscrimination testing and participation relief

As the cost of funding defined benefit plans has increased, many employers that sponsor them have taken action to limit future benefit accruals under them. Employers deciding to limit future benefit accruals generally do so in one of two ways, either: (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 — sometimes called a “soft freeze” or a “closed” plan; or (2) amending the plan to suspend any new benefit accruals for all participants —  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.  Thus, these plans may find it difficult to satisfy the Tax Code’s nondiscrimination and minimum participation requirements. The SECURE Act offers nondiscrimination and participation testing relief for certain closed or frozen defined benefit plans, subject to specific requirements.

Benefits, rights, and features test:  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 satisfy the benefits, rights, and features 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.

Testing on 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 the plan must have closed before April 5, 2017.

Minimum participation requirement:  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.

4. 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.

As described above, 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).

Beth Miller is Of Counsel at Spencer Fane LLP in the firm’s Overland Park, Kansas office.