By Alison J. Cohen, J.D., APR
On December 20, 2023, the Internal Revenue Service (“IRS”) reached into its bag of toys and bestowed upon the pension community a gift for the holidays – assorted guidance for certain provisions of the SECURE 2.0 Act of 2022 (“S2”) (Notice 2024-2 or “Guidance”). Fortunately, there were no lumps of coal, so I guess we were all good pension boys and girls this year (or simply weren’t caught). Included in this Guidance is information about a number of key provisions already in effect and several that are effective as of the New Year.
Rather than providing a superficial summary of the entire Guidance, we’ll be issuing a series of FlashPoint articles, diving into each area and providing our food for thought. In forthcoming FlashPoint articles, we’ll be covering distributions for terminal illness, employer Roth contributions (we’ll restrain ourselves from saying, “I told you so.”), de minimis financial incentives, small employer tax credits for start-up plans and military spouse credits, increased limits for SIMPLE plans, replacing SIMPLE IRAs with safe harbor 401(k) plans, and SIMPLE and SEP Roth options. Tune in later for in-depth details on those topics.
Today’s subject is the required Automatic Enrollment provisions that become effective in 2025.
A is for Automatic Enrollment
S2 Section 101 outlined that all 401(k) or 403(b) plans with a cash or deferred arrangement (“CODA”) established after December 29, 2022 (the “Enactment Date”) will be required to adopt an Eligible Automatic Contribution Arrangement (“EACA”) as of the first plan year following December 31, 2024. One mere year away. Notice 2024-2 provided guidance on how to confirm which plans would be exempt from this requirement under different circumstances. For ease of discussion, we’ll call defined contribution plans with a CODA (i.e., with elective deferrals) established before the Enactment Date “Grandfathered Plans.” (The Guidance refers to these plans as “pre-Enactment Date Plans,” but that’s a mouthful.) We will first discuss this in the context of 401(k) plans and then mention the adjustment for 403(b) plans.
What is a Grandfathered Plan?
A 401(k) Grandfathered Plan is any plan that already had a CODA in place before the Enactment Date. However, the IRS goes on to clarify for us that the grandfathering is dependent on the date of adoption preceding S2, rather than the effective date. Therefore, if I signed my brand new plan document with a CODA provision before the Enactment Date, but with an effective date after the Enactment Date, it will also count as a Grandfathered Plan. Wahoo! So, those of you who were proactive at the end of 2022 in establishing a new 401(k) Plan for 2023 are safe and won’t have to include EACA provisions in 2025. However, if an employer adopted a qualified profit-sharing plan before the Enactment Date, and added a CODA after the Enactment Date, the plan is not a Grandfathered Plan.
What About Participating Employers in a MEP or PEP?
So, let’s say that your client was a participating employer in a Pooled Employer Plan (“PEP”) or a Multiple Employer Plan (“MEP”) that included a CODA provision prior to the Enactment Date. One of the question marks with which we struggled was whether employers would get credit as Grandfathered Plans for time served in a PEP or MEP. Answer: credit will, in fact, be given! However, it’s all about the details. The participating employer doesn’t get credit just because the PEP or MEP offered the CODA before the Enactment Date. It only gets credit if its participation agreement was in place before the Enactment Date and its part of the MEP had a pre-Enactment Date CODA provision.
Example 1: Marlin & Sons was a participating employer in the Dory 401(k) MEP, effective as of January 1, 2018. The MEP contains a CODA and allows participating employers to offer the CODA provision to their employees. If the Marlin & Sons participation agreement offered the CODA provision to its employees prior to the Enactment Date, its part of the MEP would not be required to have an EACA in 2025. On the other hand, if the Marlin & Sons part of the MEP did not contain a CODA provision, that part of the MEP would not constitute a Grandfathered Plan and would be required to comply with the automatic enrollment provisions of S2 if it added such a feature.
Example 2: Suppose instead that Marlin & Sons was a participating employer in the Dory 401(k) MEP, effective as of January 1, 2018, and adopted a CODA feature for its employees in 2021. The Marlin & Sons portion of the MEP is a Grandfathered Plan.
What is the Status of a Plan that is Spun Off from a MEP or PEP?
The Guidance makes it clear that, if a participating employer in a MEP or PEP spins off its portion of the plan to a single employer plan, the Grandfathered Status of the spun-off plan is based on what it was prior to the spin-off.
Example 3: Suppose Marlin & Sons was a participating employer in the Dory 401(k) MEP with a CODA provision that was effective before the Enactment Date. Marlin & Sons then decides as of January 1, 2024, to spin-off from the MEP and start its own single employer 401(k) plan. Based on this, Marlin’s spun-off plan would be considered a Grandfathered Plan and would NOT have to adopt the EACA provision in 2025.
Example 4: Woody’s Toy Store became a participating employer in the Dory 401(k) MEP, effective as of April 1, 2023. Woody’s decides as of January 1, 2024, to spin-off from the MEP and start its own single employer 401(k) plan. Even though the Dory 401(k) MEP was in effect prior to the Enactment Date, Woody’s portion of the MEP was not. Woody’s doesn’t get credit for time in which it did not sponsor (or participate as an adopting sponsor in) a 401(k) plan, so its spin-off plan won’t be a Grandfathered Plan. If Woody had its own single employer plan that had a CODA that was merged into Dory’s 401(k) MEP prior to the Enactment Date, however, it appears that it would be a Grandfathered Plan.
Do We Treat Merged Plans as Grandfathered Plans?
If two single employer plans are Grandfathered Plans and they merge, the merged plan will retain that status after the merger. That’s the easiest situation.
The more challenging question is what to do when one plan is a Grandfathered Plan and one isn’t. Under the Guidance, the surviving plan would not be Grandfathered.
There is an exception to this situation. If two single employer plans are merged and become a single plan in connection with an acquisition or merger (i.e., a Section 410(b)(6)(C) situation) and the plan merger is completed during the coverage transition period, the status of the surviving plan controls whether the plan is or is not a Grandfathered Plan.
Example 5: Suppose Woody’s Toy Store sponsored a Grandfathered 401(k) Plan. Woody’s buys the stock of Buzz’s Model Airplanes in 2023, which sponsors a non-Grandfathered 401(k) Plan. If Woody’s then merges the two plans in 2024, and the Woody’s plan is the surviving plan, then the merged Plan will be Grandfathered.
This is when it is important to think through your strategy, because if the surviving plan after the merger is a Grandfathered Plan, then the entire kit and kaboodle gets treated as a Grandfathered Plan. But, if the surviving plan after the merger is NOT a Grandfathered Plan, then presumptively the surviving plan will need to comply with the EACA requirement in 2025.
What About Mergers of Existing Plans into a MEP or PEP?
The MEP/PEP situation is slightly different. If a single employer plan merges into a MEP or PEP, the Grandfathered Plan status of the single employer plan controls how it is treated after the merger, regardless of whether the 401(k) provision in the MEP or PEP was initially adopted or made available to participating employers before the Enactment Date.
Example 6: Bo Peep’s Sheep, Inc. sponsors a Grandfathered Plan and decides to become part of the Dory 401(k) MEP and merge its existing plan into the MEP. Because Bo Peep has a Grandfathered Plan, it will be allowed to treat its portion of the MEP as a Grandfathered Plan.
Example 7: Lightning McQueen sponsors a 401(k) plan that was initially effective January 1, 2024, so it is not a Grandfathered Plan. Suppose that Lightning McQueen merges its plan into the Dory 401(k) MEP, which is a Grandfathered Plan. Even though the Dory 401(k) MEP is a Grandfathered Plan, Lightning McQueen’s part of the MEP wouldn’t get to be treated as a Grandfathered Plan (even if the portion of the MEP in relation to other adopting employers is treated as a Grandfathered Plan).
What About 403(b) Plans?
403(b) plans are treated in the same manner as are 401(k) plans, with one small difference. If you have a 403(b) plan that was adopted prior to the Enactment Date, it will be a Grandfathered Plan whether or not it provided for elective deferrals.
Do the Mandatory EACA Rules Apply to the New Starter 401(k) Deferral-Only Plans?
Yes, as a general rule. However, as a reminder from the original rules set forth in S2 Section 101, certain new and small employers are exempt from the EACA requirements. A small employer, for this purpose, is one that has fewer than 11 employees. The new employer is one that has been in existence for fewer than three years (this includes predecessor employers).
What Happens if We Make a Mistake with Automatic Enrollment?
Section I of the Guidance provides Q&A for how Congress has changed the rules for correcting an enrollment problem with automatic enrollment plans. In Revenue Procedure 2021-30 (“EPCRS”), Appendix A, the IRS provided a correction window for plans with automatic enrollment or escalation provisions. This window allowed plan sponsors to correct active employees without requiring that the employer make a Qualified Nonelective Contribution (“QNEC”). The language in the original notice template advised active employees that they could increase their future deferrals to make up for the missed time. Because of this, the IRS insisted that the QNEC waiver did not apply to terminated employees and those employees had to receive the 50% QNEC. (Both active and terminated affected employees also had to receive the full missed matching contribution, if any.) The EPCRS provision expired December 31, 2023. S2 Section 350 added new Code Section 414(cc) to modify and extend this correction.
There is an important deadline to correct automatic enrollment failures under this favorable provision, and it is the same under Code Section 414(cc) as it was under EPCRS. Correct deferrals must begin no later than the first payroll after the earlier of (a) 9 ½ months after the end of the plan year in which the failure occurred; or (b) the last day of the month following the month during which the employee notifies the employer of the error. For a calendar year plan, that means the employer can correct the failure by October 15 of the following year unless the employee points out the mistake earlier.
Under the Guidance, the IRS has clarified that, in accordance with the language in S2 Section 350 and the newly enacted Code Section 414(cc), terminated employees are now covered by the no-QNEC correction provision. Further, in accordance with the S2 changes to the self-correction rules, the Notice to terminated participants that is required to be given per EPCRS no longer needs to include language regarding the start of the correct deferral amounts and the increase in deferral amounts for the remainder of the year. The missed matching contributions will still need to be made to all improperly excluded participants.
Remember that rules under EPCRS regarding the 45-day notice still apply, and notice to affected participants must be provided within 45 days after correct deferrals begin (or would have begun in the case of a terminated participant).
There are several key differences between the new Code Section 414(cc), as interpreted by the Guidance, and the expired EPCRS provision:
- The new law can correct failures for participants who have terminated employment.
- The new law can correct failures in all plan types, including governmental and tax-exempt 457(b) plans.
- As described below, there is a time limit under the new law to contribute the missed matching contributions.
- An employer can self-correct under the new law, even if an IRS audit discloses the error.
This is definitely good news. And there is more good news. S2 applied a January 1, 2024, effective date to the new Code provision. The IRS interprets Code Section 414(cc) as applying to errors which began before 2024, so long as the deadline to correct the failure is after December 31, 2023.
Example 8: Wayfinder Boats offers an automatic enrollment 401(k) plan with a March 31 plan year end. Moana enters the plan on April 1, 2022, and files an election to defer 5% of compensation, which would entitle her to a 50% match. Wayfinder fails to implement her election, but Moana is too busy with other things and doesn’t notice. Wayfinder issues paychecks on Fridays. The deadline to correct the failure is January 19, 2024, the first payday that is at least 9½ months after the March 31, 2023, end of the plan year in which the failure occurred. As this deadline is after December 31, 2023, Wayfinder can correct the failure under Code 414(cc), even if Moana terminated employment, and even if the IRS discovered the failure under audit.
Example 9: Assume the same facts as Example 8, except the plan has a calendar plan year. The deadline to correct the failure was October 20, 2023. Since that deadline is before January 1, 2024, Wayfinder cannot use the new Code provision. If Moana had terminated employment before the correction, Wayfinder would need to pay a 50% QNEC to correct the missed deferrals, as well as correcting the missed match.
Example 10: Assume the same facts as Example 8, except observant Moana noticed the error in January of 2023, and brought it up to Wayfinder’s HR Director. The deadline to correct the error was March 3, 2023. Again, Code 414(cc) is not available to correct failure.
Whether the automatic enrollment correction is made under pre-S2 EPCRS rules or under Code Section 414(cc), the plan sponsor must make a contribution equal to any missed employer match caused by the failure. The Guidance clarifies that, under Code Section 414(cc)(2)(B)(ii), this amount (plus applicable earnings) must generally be deposited to the plan within six months after the date that correct automatic enrollment begins for the affected participants. However, as this timing requirement is new under the Guidance, there is a grace period for older corrections. In particular, if the automatic enrollment failure occurred prior to December 31, 2023, the employer has until the end of the third plan year following the year in which the failure occurred to deposit the missed matching contribution and earnings.
Example 11: Assume the same facts as Example 8. Wayfinder has until March 31, 2026, the end of the third plan year following the year in which the failure occurred, to deposit the missed matching contributions and earnings for Moana.
Now we know how to treat both spin-off and merger plans with respect to the new mandatory automatic enrollment rules. We also know how to apply the EPCRS terms to any automatic enrollment failures, which will be much more favorable to plan sponsors, since it will decrease the cost for correcting terminated employees.
We look forward to sharing more with you in our next Flashpoint newsletter. And always remember, we are your ERISA solution!
On January 11, 2024, Ilene, Derrin, and Alison will be presenting the ERISApedia webinar, “SECURE 2.0 Grab Bag: The IRS Christmas Present,” on the Guidance. If you haven’t already registered for the session, go to www.erisapedia.com and check out Upcoming Webcasts to do so.
- Posted by Ferenczy Benefits Law Center
- On January 3, 2024