Treatment of Student Loan Payments as Elective Deferrals for Purposes of Matching Contributions

Effective for contributions made for plan years beginning after December 31, 2023, the Act allows eligible employees to receive matching contributions by reason of making payments on their student loans. This provision permits an employer to make matching contributions to a 401(k) plan, 403(b) plan, or SIMPLE IRA for “qualified student loan payments.” A qualified student loan payment is broadly defined as any indebtedness incurred by an employee solely to pay qualified higher education expenses of the employee. 

Governmental employers are also permitted to make matching contributions to a 457(b) plan or other plan related to student loan payments. 

For purposes of the nondiscrimination test for elective contributions, the new provision permits a plan to separately test the employees who receive matching contributions on student loan repayments. 

Comment: This provision is optional and will be of particular interest to employers who hire college graduates, for example, professional firms and companies that need a well-educated workforce.

 

Withdrawals for Certain Emergency Expenses 

Generally, an additional 10% tax applies to early distributions from tax-preferred retirement accounts, such as 401(k) plans and IRAs, unless an exception applies. Effective for distributions made after December 31, 2023, the Act provides an exception for distributions for emergency expenses which are unforeseeable or create immediate financial needs relating to personal or family emergency expenses. 

Only one distribution is permissible per year of up to $1,000, and a taxpayer has the option to repay the distribution within 3 years. No further emergency distributions are permissible during the 3-year repayment period unless repayment occurs. 

Comment: This provision is also optional. It’s likely to be attractive to companies with low or moderately paid employees who may need the extra money for emergencies.

 

Starter 401(k) and 403(b) plans are a simple way for small employers to set up retirement plans for their employees with little, if any, cost.

 

Starter 401(k) And 403(b) Plans for Employers With No Retirement Plan

Under the SECURE 2.0 Act, an employer that doesn’t sponsor a retirement plan will be able to offer a starter 401(k) plan (or safe harbor 403(b) plan). 

Starter 401(k)s and safe harbor 403(b)s generally require employees to be default enrolled into the plan at a deferral rate of 3-15% of compensation. The limit on annual deferrals will be the same as the IRA contribution limit, which for 2022 is $6,000 with an additional $1,000 in catch-up contributions beginning at age 50. 

Comment: This new deferral-only plan is a simple way for small employers to set up retirement plans for their employees with little, if any cost. As a result, this design should be highly competitive to state-mandated IRA-based savings plans.

 

Catch-up Contributions as Roth Deferrals

For tax years after December 31, 2023, catch-up deferrals to qualified plans must be treated as Roth deferrals for participants who make more than $145,000 per year (indexed).

Comment: Under current law, plan sponsors can allow participants to make pre-tax or after-tax catch-up contributions. Under this provision, Roth treatment for all catch-up deferrals will be mandatory for those making over $145,000 (indexed) in 2024. As a result, financial professionals should consider helping the affected participants by informing them of this change. 

 

Special Rules for Certain Distributions From 529 Plans to Roth IRAs 

The SECURE 2.0 Act amends the Internal Revenue Code to allow for tax- and penalty- free rollovers from 529 accounts to Roth IRAs, under certain conditions. Beneficiaries of 529 college savings accounts would be permitted to roll over up to $35,000 over the course of their lifetimes from any 529 account in their name to a Roth IRA. 

These rollovers are subject to Roth IRA annual contribution limits, and the 529 account must have been open for at least 15 years. A further limit is that the amounts rolled over cannot exceed the sum of the contributions and earnings five years before the date of the rollover.

This change is effective for distributions after December 31, 2023.

Comment: While some commentators are describing this as a tax planning opportunity, the purpose of the provision was to encourage the funding of 529 plans for educational purposes. The sentiment of the policy makers is that individuals are more likely to fully fund 529 plans if they know that any money remaining on the 529 account after payment of education costs can benefit the student via a rollover to a Roth IRA for the student.

 

Emergency Savings Accounts Linked To Individual Account Plans

This new provision will allow employers the option of offering their non-highly compensated employees “pension-linked emergency savings accounts” (commonly referred to as “side car savings accounts”). 

Employers may automatically enroll employees into these accounts at no more than 3% of their pay, or the plan can use regular enrollment. Either way, the portion of a savings account attributable to an employee’s contribution is capped at $2,500 (or lower as set by the employer). 

Once the cap is reached, any additional contributions can be directed to the employee’s Roth account in the plan (if they have one) or stopped until the balance attributable to contributions and earnings falls below the cap. 

Contributions are made on a Roth-like basis and are treated as elective deferrals for purposes of matching contributions. Note, though, that matching contributions must first applied against any regular deferrals to the plan. Any matching contributions based on employee contributions to the savings account must be allocated to the plan’s matching account and not to the savings account.

The first four withdrawals each plan year cannot be subject to any fees. Any additional withdrawals in a plan year can be assessed a reasonable fee. 

At separation from service, employees may take their emergency savings accounts (i) as cash, (ii) roll it into their Roth account in the plan (if they have one), or (iii) roll it to a Roth IRA.

Comment: This new optional provision will likely be most attractive to employers with significant numbers of low to mid-paid employees. As the pandemic illustrated, many employees need savings to weather financial disruptions, but haven’t accumulated savings on their own. The implementation of this provision will require a significant of work by recordkeepers, for example, developing the technology and communications materials, before it can be adopted by employers. Financial professionals will need to coordinate with recordkeepers to determine when this savings program will be available to their plan sponsors.

 

Amendments To Increase Benefits for Previous Plan Year Allowed Until Employer Tax Return Due Date

The SECURE (1.0) Act permitted an employer to adopt a new retirement plan by the due date of the employer’s tax return for the year in which the plan is effective. Current law, however, provides that plan amendments to an existing plan must generally be adopted by the last day of the plan year in which the amendment is effective. This precludes an employer from amending plans after the year end in ways that may be beneficial to participants. 

The SECURE 2.0 Act amends these provisions to allow discretionary amendments that increase participants’ benefits to be adopted by the due date of the employer’s tax return.

Comment: This is another optional provision. It will provide flexibility to employers by allowing them to better consider their financial situations before committing to responsibility for increased contributions.

 

Additional Provisions That Become Effective After December 31, 2023

• Indexing IRA catch-up limit: Under current law, the limit on IRA contributions is increased by $1,000 (not indexed) for individuals who have attained age 50. The Act indexes the limit for cost-of-living increases.
• Allow additional nonelective contributions to SIMPLE plans: Current law requires employers with SIMPLE plans to make employer contributions for employees of either 2% of compensation or matching contributions of 3% of deferrals. Beginning in 2024, the Act permits an employer to make additional contributions for employees in a uniform manner, provided that the contribution may not exceed the lesser of 10% of compensation or $5,000 (indexed).
• Updating dollar limit for mandatory distributions: Under current law, plans can “force out” former employees’ retirement accounts from retirement plans to IRAs if their balances are $5,000 or less. The Act increases the limit from $5,000 to $7,000.
• Application of top-heavy rules to defined contribution plans covering excludable employees: The Act allows an employer to perform the top-heavy test separately on the non-excludable employees and excludable employees (e.g., those who are under age 21 and have less than 1 year of service), which would, in effect, mean that top-heavy contributions would not be required for excludable employees. This removes the financial incentive to exclude employees from 401(k) plans and increase retirement plan coverage to more workers.
• Penalty-free withdrawal from retirement plans for individual case of domestic abuse: The Act allows retirement plans to permit participants that self-certify that they experienced domestic abuse to withdraw a small amount of money (the lesser of $10,000, indexed for inflation, or 50% of the participant’s account). A distribution made under this provision is not subject to the 10% tax on early distributions. Additionally, a participant has the opportunity to repay the withdrawn money from the retirement plan over 3 years and will be refunded for income taxes on money that is repaid.
• Employers allowed to replace SIMPLE retirement accounts with safe harbor 401(k) plans during a year: The Act allows an employer to replace a SIMPLE IRA plan with a SIMPLE 401(k) plan or other 401(k) plan that requires mandatory employer contributions during a plan year. 
• Hardship withdrawal rules for 403(b) plans: For 401(k) plans, all amounts are available for hardship distributions. For 403(b) plans, in some cases, only employee contributions (without earnings) are available for hardship distributions. The Act conforms the 403(b) rules to the 401(k) rules.

 

The provisions that are effective in 2024 present opportunities to employers, rather than mandating changes.

 

Concluding Thoughts

Of the provisions that become effective in 2024, those that will be most often used in plan design are likely to be:

• Starter plans: This new plan design is appropriate for employers who want to offer a plan to their employees, but who may not have the cash flow or who otherwise have cost concerns about their ability to fund a plan. This design is competitive with state-mandated arrangements and offers the potential for lower costs and more services than IRA-based plans.
• Matching contributions for student loan repayments: This option will likely be attractive to employers who hire recent college graduates. That could include professional firms, technology companies, chemical and pharmaceutical companies, among others. Financial professionals should consider consulting with their plan sponsor clients about this new feature.
• Side car savings accounts: While the matches for student loan repayments may appeal to employers of college graduates, this feature will likely be appealing to those employers who have significant numbers of low to moderate paid employees. The pandemic has shown that many employees don’t have the savings to endure even short periods of time without an income source.

For the most part, the provisions that are effective in 2024 present opportunities to employers, rather than mandating changes. As a result, they create opportunities for financial professionals to provide value to their plan sponsor clients by informing plan sponsors of the new opportunities and helping plan sponsors make decisions about those possibilities.