SECURE Act 2.0: Key changes for 401(k) plans in 2023

In 2019, the SECURE Act introduced a number of changes to rules for retirement plans and IRAs. Now SECURE Act 2.0, which was included in the Consolidated Appropriations Act, 2023, has more than 90 provisions impacting retirement plans and IRAs. These changes include something for everyone … low- and modest-income individuals, wealthy people, small businesses, and others. It became law on Dec. 29, 2022, but many of the provisions do not come into effect until 2024 or even much later. The following is a year-by-year overview of key provisions that may affect you and your employees. Because some effective dates are expressed in terms of taxable years or plan years, for simplicity here it is assumed that taxpayers and qualified retirement plans are on a calendar year.

Changes effective before or in 2023

Businesses need to acclimate to new rules effective this year.

Increased starting age for RMDs. For 2022, the starting age for taking required minimum distributions was 72. This year, anyone who turns age 72 after 2022 has a starting age of 73. Looking ahead, the age will jump to 75 in 2033 for those who attain age 74 on or after Jan. 1, 2033.

Reduced penalty for insufficient RMDs. The 50% penalty is reduced to 25%. And if the failure is corrected within a certain period, the penalty declines to 10%. It is not clear whether the IRS can waive the penalty for reasonable cause, as was possible before this year.

Related: SECURE 2.0 Act: New rules for advisors and plan sponsors in 2023

Penalty-free withdrawals for terminal illness. The 10% penalty for distributions before age 59½ no longer applies to distributions to someone with a terminal illness.

QLACs expanded. Qualified longevity annuity contracts purchased with plan benefits allow for deferral of RMDs and ensure that the person has income for life. For 2022, the maximum that could be added to a QLAC is 25% of the account balance up to a maximum premium of $145,000. Starting this year, there is no 25% limit, and the maximum amount is $200,000 indexed for inflation.

Disaster distributions and loans. For federal disasters occurring on or after Jan. 26, 2021, withdrawals up to $22,000 within 180 days of the event are not subject to a 10% early distribution penalty; they are subject to tax. Such distributions may be recontributed within three years and taxes paid can be recouped. Disaster loans are permitted up to the lesser of $100,000 or 100% of the account balance. What’s more, for participants living in a federal disaster area and suffering an economic loss, plan loan payments may be delayed for one year and the usual five-year payment deadline can be extended by one year.

Recontributing birth or adoption distributions. Participants are not penalized for taking a distribution from a qualified retirement plan up to $5,000 to pay for the costs of birth or adoption. The distribution can be repaid to the plan. SECURE Act 2.0 makes it clear that there is a three-year repayment period beginning the day after the distribution.

Increased credit for small employer pension plan startup costs. For 2022, the credit was 50% of administrative costs, up to $5,000, and could be claimed for three years. Under SECURE Act 2.0, the credit is doubled to 100% of costs and runs for five years. However, this enhanced credit only applies to employers with up to 50 employees. A phased-out credit applies for employers with between 51 and 100 employees. The credit limit for the very small employers is 100% for the first two years, 75% for the third year, 50% in the fourth year, and 25% in the fifth year. The new law also makes it clear that the credit may be claimed by a business that joins a multiple employer plan (MEP), and this is retroactive to 2020.

Enrolling military spouses in company plans. There is a new credit, effective as of Dec. 29, 2022, for a small employer that enrolls a military spouse of an employee in the company’s retirement plan. The credit is the sum of $200 for such individual who participates in an employer plan, plus the amount of employer contributions not exceeding $300. Military spouses may be enrolled within two months of the employee’s hiring and is treated as having two years of service for purposes of matching or nonelective contributions.

Small incentives. Employers can now give employees a small incentive to induce them to make elective salary deferrals. The incentive must be a low-cost gift card (what is “low-cost” remains to be defined). This cannot be paid for with plan assets; employers have to use company funds for this purpose.

Notices to employees. Plans do not have to send certain notices to employees who are not enrolled in the plan. However, this change does not apply to the annual reminder notice about eligibility to participate.

Changes effective in 2024

It is not too early to consider the changes that become effective next year.

Emergency savings accounts and withdrawals. A plan may allow for an emergency savings account, but only for non-highly compensated employees. If the plan permits it, eligible employees can defer up to the lesser of 3% of compensation or $2,500 to the emergency savings account. This is an after-tax contribution like amounts put into designated Roth accounts. Amounts can be rolled over to a designated Roth account or Roth IRA. A plan may also permit penalty-free withdrawals up to $1,000 per year for “unforeseeable or immediate financial needs related to necessary personal or family emergency expenses.” Only one such distribution may be taken every three years; withdrawals can be recontributed within three years.

Nonelective contributions to SIMPLE IRAs. The Act allows employers with SIMPLE IRA plans to make additional nonelective contributions for all eligible employees in a uniform manner, provided that the contribution does not exceed the lesser of up to 10% of compensation or $5,000 per employee per year (indexed for cost-of-living beginning in 2025).

Penalty-free withdrawals for domestic abuse. A domestic abuse survivor may withdraw the lesser of $10,000 or 50% of the account balance. This withdrawal is taxable, but not subject to the 10% early distribution penalty. The funds can be recontributed within three years.

Starter 401(k). Employers that do not have any qualified retirement plan can use a “starter 401(k) plan” funded entirely with employees’ elective deferrals. These are not less than 3% or more than 15%. Elective deferrals are automatic for those eligible to participate; employees can opt out. Elective deferrals are limited to annual IRA contribution limits, not the 401(k) limits.

Student loan payments treated as elective deferrals. Beginning in 2024, employees who pay off student loans rather than making elective deferrals to a 401(k) or other plan can have their payments treated as “qualified student loan payments” eligible for employer matching contributions.

Rollover of long-term qualified tuition programs. After 2023, funds in a 529 plan that has been open for more than 15 years may be rolled over to a Roth IRA without tax or penalty. The rollover limit is capped at $35,000 in a lifetime, and are also subject to Roth IRA annual contribution limits.

Changes effective after 2024

Some changes do not apply until 2025 or later.

Expanded catch-up contributions. Beginning in 2025, those ages 60, 61, 62, and 63 by the end of the year can contribute the greater of $10,000 or 150% of the regular catch-up amount in effect in 2024.

Government matching contributions. Beginning in 2027, the retirement savers credit is replaced by a Saver’s Match. Like the current credit, the match would be a maximum of $1,000 (50% of $2,000 contributed by an individual to a retirement plan or IRA). Income limits cap eligibility, and the match phases out for income above a set amount per filing status.

Automatic enrollment. Employees eligible to participate in an employer’s 401(k) plan must be automatically enrolled to make elective deferrals. The starting amount is between 3% and 10%. This amount will increase by 1% each year, up to a maximum of at least 10%, but not more than 15%. This measure is effective in 2025.

Related: Your 401(k) plan re-imagined: How tech plays a role (now that SECURE 2.0 has passed)

Coverage for part-timers. Beginning in 2025, it becomes easier for long-term part-time employees to become eligible to participate their employer’s a 401(k) plan. Eligible employees are those who complete either one year of service (with the 1,000-hour rule) or three consecutive years of service (where the employee completes at least 500 hours of service). But after 2024, only two consecutive years of service is needed for eligibility.

Long-term care contributions. Starting Dec. 29, 2025, plans may distribute up to $2,500 annually for a participant to pay certain specified long-term care insurance contributions. Such distributions are penalty free.

S-ESOPs. Tax deferral applies for the sales of corporate stock to an employee stock ownership plan (ESOP). Currently, this was restricted to C corporations. For sales after 2027, it also applies to sales of S corporation stock.

This is not a complete explanation of all the provisions in SECURE Act 2.0. It is advisable to review the law and watch for IRS guidance on new rules taking effect this year, next year, or even later.

Sidney Kess is CPA-attorney, is of counsel at Kostelanetz & Fink.