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SECURE Act & its Impact on Self-Directed Plans

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A Summary of the Key provision of the SECURE Act & Its Potential Impact on Self-Directed IRAs and Solo 401(k) Plans

The Setting Every Community Up for Retirement Enhancement (SECURE) Act, which passed last Thursday in the House of Representatives by a 417-3 vote, aims to improve the nation’s retirement system. It includes 29 provisions, many of which provide new opportunities to save, whether you’re three or 30 years away from exiting the workforce.

The bill should soon make its way to the Senate, where lawmakers are floating similar legislation with bipartisan support. With both chambers and political parties appearing to be aligned on the issue, retirement experts say the SECURE Act – or another bill closely resembling it – could soon be signed into law.

The SECURE Act closely mirrors the Retirement Enhancement and Savings Act of 2019 (S. 972) (RESA) introduced on April 1, 2019 by Senate Finance Committee Chairman Charles Grassley (R-IA) and Ranking Member Ron Wyden (D-OR).

The SECURE Act offers a number of very interesting provisions that could potentially impact certain self-directed IRA and solo 401(k) plan investors.

Below please find a summary of some of the key provisions of the SECURE Act.

Multiple-Employer Plans (MEPs)

A multiple employer plan (MEP) is a plan (other than a Taft-Hartley plan) maintained by two or more unrelated employers. MEPs are treated as a “single plan” for ERISA purposes. The idea behind increasing the popularity of MEPs is that it would reduce the costs associated with establishing and operating a 401(k) plan based off theconcept of cost sharing and aggregation of costs.

More participants in the plan will allow the plan to have more leverage over investment advisors and plan record-keepers to better control costs.

MEPs are currently not overly popular because of the following two rules:

1. Common Interest Rule

Under current Department of Labor (DOL) guidance, MEPs may be established or maintained only by employer members to share a common economic or representational interest or genuine organizational relationship unrelated to the provision of benefits. This is known as the “common interest” requirement.

2. One Bad Apple Rule

Under the Code, if just one employer participating in a MEP runs afoul of the plan qualification rules, the entire MEP may be disqualified. This is often referred to as the “one bad apple” rule.

Under the SECURE Act, unrelated employers would be allowed to participate in a MEP, called a “pooled employer plan,” that would be treated as a single plan for ERISA purposes. The “common interest” and “One Bad Aple” rules would no longer apply. In addition, the MEP would be required to file only one annual information return for all plan participants (IRS Form 5500). Note – the RESA Act has a very similar proposal for MEPs.

The MEP proposal has received very favorable public opinion and it is highly expected to be part of a final retirement bill.

Start-Up Credit for New Employer Plans

Employers with generally up to 100 employees are eligible for an annual tax credit for three years equal to 50% of certain costs paid or incurred in connection with starting a retirement plan, up to a cap on the annual credit of $500. The SECURE Act and RESA Act would increase the annual credit to the greater of (1) $500 or (2) the lesser of (a) $250 for each non-highly compensated employee who is eligible to participate in the plan or (b) $5,000.

Expanded Definition of “Compensation” for IRA Contributions

Both the SECURE ACT and RESA Act would amend the definition of “compensation” on which IRA contributions may be based. It would be amended to include “any amount which is included in the individual’s gross income and paid to the individual to aid the individual in the pursuit of graduate or postdoctoral study.

Part-Time Employee 401(k) Plan Eligibility

The SECUREA Act would require employers maintaining a 401(k) plan to have a dual eligibility requirement under which an employee must complete either: (a) one year of service (with the 1,000-hour rule); or (b) three consecutive years of service where the employee completes at least 500 hours of service. Note – the RESA act does not include a similar provision.

Plan Withdrawals for Birth or Adoption

Distributions from a qualified retirement plan, 403(b) plan, 457(b) plan, or IRA are generally included in income for the year unless an exception applies. For example, in-service plan distributions of elective deferrals from a qualified retirement plan, 403(b) plan, or 457(b) plan are generally not permitted, unless a specific exception applies. Under current law, the birth or adoption of a child is not on the safe harbor list.

Under the SECURE Act, qualified birth or adoption distributions from a retirement plan or IRA (a) could be distributed regardless of whether an in-service distribution is otherwise permitted; (b) would be exempt from the 10% early distribution tax penalty; (c) would be exempt from the mandatory 20% withholding and 402(f) notice otherwise required when distributed from a retirement plan; and (d) could be repaid to certain retirement plans and IRAs without regard to the usual 60-day time limit for rollovers.

Any distribution from an IRA, qualified defined contribution plan, 403(b) plan, 403(a) plan, or governmental 457(b) plan that is taken within 1 year of a birth or adoption would be treated as a “qualified birth or adoption distribution,” subject to the following conditions:

  • Qualified birth or adoption distributions would be limited to $5,000 (not indexed) per birth or adoption
  • Qualified birth or adoption distributions would not include the adoption of a child of the taxpayer’s spouse
  • Qualified birth or adoption distributions would be limited to the adoption of children who are either under age 18 or physically or mentally incapable of self-support

The $5,000 limit applies on an individual basis, meaning spouses could each receive a distribution of up to $5,000 per qualifying birth or adoption.

The RESA Act does not contain a similar provision.

70 1/2 years – 72 years

Under current law, required minimum distributions (RMDs) generally must begin by April 1 of the calendar year following the calendar year in which the individual (employee or IRA owner) reaches age 70½, subject to an exception for certain plan participants. This deadline is called the “required beginning date.” Under the SECURE Act, the age for triggering the required beginning date for RMDS would be changed from 701/2 for plans and IRAs to 72.

401(k) Plan Adoption Deadline

Under current law, a plan must be adopted by the last day of the taxable year of the employer in order to be in effect for such year. For example, the plan need not be funded by that date, the employer must formally adopt the plan and trust documents by the end of its taxable year. Under the SECURE Act and RESA Act, an employer would be allowed to adopt a plan for a taxable year as long as the plan is adopted by the due date for the employer’s tax return for that year (including extensions).

This change would apply to plans adopted for taxable years beginning after December 31, 2019.

Annuities & 401(k) Plans

In general, an annuity is a long-term investment that is issued by an insurance company designed to help protect you from the risk of outliving your income. Through annuitization, the retirement account contributions are converted into periodic payments that can last for life. Annuities are not currently a popular investment options for 401(k) plans largely because of the potential risks to the trustee of the plan (fiduciary). Under ERISA, a fiduciary is required to discharge its duties with respect to a plan solely in the interest of participants and beneficiaries. Fiduciaries must act with the care, skill, prudence, and diligence under the circumstances that a reasonable prudent person acting under similar circumstances would use. This is called the prudent person requirement. The concern on the part of the trustee of the plan is that if the insurance company responsible for the annuity investment goes bankrupt, the trustee of the plan could have some liability risk.

The SECURE Act and RESA Act would try to insulate the trustee for potential liability risk for offering annuity investments by including adding the following safe harbor provision:

Allow defined contribution plan fiduciaries to rely on written representations from insurers regarding their status under state insurance law for purposes of considering the insurers’ financial capabilities;

  • Specify that a fiduciary is not required to select the lowest-cost contract but may also consider the value provided by other features and benefits and attributes of the insurer;
  • Clarify that fiduciaries are not required to review the appropriateness of a selection after the purchase of a contract for a participant or beneficiary; and
  • 529 Plan Funds to Pay Student Loans

Under current law, 529 plan withdrawals that are used to repay student loans are not deemed 529 plan “qualified higher education expenses.”

Under the SECURE Act, the definition of qualified higher education expenses for 529 plans would be expanded to include amounts paid as principal or interest on any qualified education loan of a 529 plan designated beneficiary or a sibling of the designated beneficiary (i.e., those amounts would be withdrawn tax-free). The amount treated as a qualified expense “with respect to the loans of any individual” is subject to a lifetime limit of $10,000. Note – a similar provision is not included in the RESA Act.

“Stretch RMD”

This one of the most controversial provisions in the SECURE Act. Under current law, required minimum distribution (RMD) rules generally require plan participants to begin taking distributions shortly after the participant reaches age 70½. Under current law, the after-death RMD rules permit a designated beneficiary to draw down the remaining plan benefits over the beneficiary’s life expectancy. For example, if a child is designated as a beneficiary of an IRA for RMD purposes, current law, would allow the child to take RMDs over her life expectancy, thus, allowing the child to stretch the value of the IRA and maximize its tax deferral potential.

Under the SECURE Act, on the death of an IRA owner or defined contribution plan participant, the individual beneficiary would be required to draw down his or her entire inherited interest within ten years. This rule would apply regardless of whether RMDs had begun prior to the owner/participant’s death. The new rules would not apply to defined benefit plans, but would apply to IRA annuities.

However, the ten-year rule would not apply to any portion payable to an “eligible designated beneficiary” if such portion will be (1) distributed over the beneficiary’s life or a period not exceeding his or her life expectancy and (2) such distributions begin within one year of the death. An eligible designated beneficiary is any designated beneficiary who is:
the surviving spouse;

  • A child under the age of majority
  • Disabled or chronically ill
  • Any other person who is not more than 10 years younger than the participant/IRA owner

In the case of a child who has not attained the age of majority the ten-year rule would apply as of the date the child attains the age of majority. The 10-year rule also would apply upon the death of any eligible beneficiary. In addition, non-individual beneficiaries, such as estates and charities, which are subject to a five-year rule and cannot “stretch” our payments will still apply under the SECURE Act.

Under the RESA Act, the stretch IRA would be limited in a different manner. The RESA version requires distributions to occur within five years of death, except in the case of an “eligible designated beneficiary.” However, RESA would exempt from this requirement up to $400,000 (indexed) per designated beneficiary.

Conclusion

Overall, both the SECURE Act and RESA Act offer a number of very interesting and potentially helpful provisions that should make saving for retirement easier and less costly. For example, increasing the RMD age to 72 is a much-needed change based on the increased life expectancy of Americans. In addition, allowing one to establish a solo 401(k) plan prior to filing the return instead of by 12/31 of the prior year will be very helpful. Moreover, including an exemption for child birth and adoption from the early distribution penalties is also helpful.

However, the limitations on the “stretch RMD” is a distressing provision that could negatively impact one’s desire to increase savings through retirement funds. Nevertheless, on the whole, the SECURE Act should be viewed positively by self-directed IRA and Solo 401(k) Plan investors.

It is now up to the Senate to decide what to do with the SECURE Act. Lawmakers The Senate could either vote for it or against it – or ultimately decide to revise some of its provisions. Since both the House and the Senate both seem to be on the same age regarding the need to increase retirement account participation and retirement savings for Americans, it seems likely that some version of the SECURE Act and RESA Act will one day become law, most likely towards the end of 2019.

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