Larger Tax Credit Available For New Retirement Plans
When the Setting Every Community Up for Retirement Enhancement (SECURE) Act was passed into law in December 2019, significant changes impacting retirement accounts were put into motion. Considered to be the most substantial update to the laws governing retirement accounts since the 2006 Pension Protection Act, the legislation helps business owners with new retirement plans “secure” a larger tax credit, gives employers more options when it comes to deciding which type of plan to implement, delays the age individuals are required to take required minimum distributions (RMDs), provides plan administrators with more options when it comes to helping business owners maximize their company’s retirement plan, and more.
This article will provide you with an overview of some new and exciting opportunities now available as a result of the new SECURE Act.
New Plans Get Larger Tax Credit
Beginning Jan. 1, 2020, under the SECURE Act, the tax credit amount available for the first three years of a company’s retirement plan will be capped at $250 times the number of eligible employees – with a maximum of $5,000/annually (but never less than $500), limited to 50 percent of the start-up costs. Additionally, if the new plan takes advantage of automatic enrollment, the employer will receive an additional annual credit for start-up costs of $500/annually for three years. In the past, tax credits for businesses with new retirement plans would have been capped at $500.
In other words, there’s never been a better time for businesses to start up a new retirement plan.
To see the SECURE Act’s tax incentive in action, consider the following example:
A small business owner with 15 employees on the payroll recently established a new safe harbor 401(k) plan. To help maximize the retirement readiness of the company’s employees, the owner chose to implement automatic enrollment. To get the plan up and running, the business’s out-of-pocket cost totaled $3,500 for the first year, and $2,500 recurring. Using this scenario, the tax credit now available to this business for the first is $2,250 – or $1,750 (half of the plan’s start-up cost) plus $500 (the automatic enrollment incentive). For the second and third years of the plan, the tax credit will be $1,250 – (or half the plan’s recurring cost of $2,500).
Additionally, any remaining plan cost after the tax credit has been claimed is deductible as a normal business expense, which also pertains to all plan contributions made by the client.
Now, however, thanks to the SECURE Act, employers are now able to adopt a qualified retirement plan after the close of a taxable year, as long as it’s adopted before the deadline for filing the employer’s tax return for the taxable year. This option will exist for retirement plans adopted for taxable years after Dec. 31, 2019.
Last-Minute Retirement Plan Options For Businesses
Previously, the only type of workplace retirement plan that could be established after the close of the taxable year was a Simplified Employer Pension (SEP), which is an IRA-based plan that only allows an employer profit sharing contribution. For all other qualified workplace retirement plans, the plan document needed to be executed prior to the end of the taxable year in which it was being adopted for contributions to be deductible in that year. Now, however, thanks to the SECURE Act, employers are now able to adopt a qualified retirement plan after the close of a taxable year, as long as it’s adopted before the deadline for filing the employer’s tax return for the taxable year. This option will exist for retirement plans adopted for taxable years after Dec. 31, 2019.
This particular change in the law is significant because it allows for a lot more flexibility when it comes to making the decision to implement a qualified plan after the end of the taxable year – especially for cash balance plans.
Legislation Secures Additional Opportunities
Other legislative changes that will positively impact non-elective contribution 401(k) safe harbor plans include:
- The elimination of the safe harbor notice requirement with respect to non-elective 401(k) safe harbor plans.
- Allowing plans to be amended to become non-elective 401(k) safe harbor plans at any date before the 30th day before the close of the plan year.
- Allowing plans to be amended to become a no-elective 401(k) safe harbor plan after the 30th day before the close of the plan year – IF the plan is amended to provide for a non-elective contribution of at least four percent of compensation for all eligible employees, and the amendment is made generally by the close of the following plan year. Effective for plan years after Dec. 31, 2019.
These changes are valuable because they allow plan administrators to have more flexibility when it comes to identifying and implementing plans designed to maximize contributions to owners.
Wondering what a retirement plan census is? Find out on this episode of Rea’s award-winning podcast, unsuitable on Rea Radio.
RMD changes under the SECURE Act
Prior to the SECURE Act, individuals with IRA accounts or qualified employer-sponsored retirement plans were required to take RMDs beginning the year they turned 70 ½ years old, with a deadline (for the first RMD only) of April 1 the following year. Beginning in 2020, RMDs must now start at age 72 (with a deadline of April 1 the following year).
Notably, RMDs for individuals who turned 70 ½ years old in 2019 are not delayed. Instead, those individuals must continue to take their RMDs under the same rules prior to the SECURE Act. Despite the delay in the starting age for RMDs, Qualified Charitable Distributions from IRAs will not be affected by the SECURE Act. Accordingly, Qualified Charitable Distributions may still be taken from IRAs as early as age 70 ½.
Those born in the first half of the year will receive a longer delay of the first RMD than those born in the second half of the year. This is because those with birthdays in January through June reach age 70 and 70 ½ in the same year, so their first RMD is not required until two years later at age 72. However, people with birthdays July through December will reach age 70 ½ in the same year they turn 71. As a result, their first RMD is delayed until the following year at age 72.
While the delayed RMD starting age may not impact you, the retirement plan administration team at Rea & Associates is available to discuss your options on this or any other piece of the SECURE Act that you would like to learn more about. For example, strategically timed Roth Conversions can be an effective tool to accelerate income in a tax-efficient manner, leveraging the additional time IRA owners are afforded before their RMDs begin, which increases their annual income.
Additional Noteworthy Retirement Plan Changes
Increase in 10 percent cap for automatic enrollment safe harbor after the plan’s first year.
This change modifies the automatic enrollment safe harbor to raise the automatic escalation cap from 10 percent of pay to 15 percent of pay, allowing employers to automatically increase the amount their employees defer from their paychecks to 15 percent, which is usually done in one percent increments annually.
401(k) plans must allow long-term, part-time employees to make salary deferrals
Under the current law, employers generally may exclude part-time employees who work less than 1,000 hours per year when providing a retirement plan. Except in the case of collectively bargained plans, employers maintaining a 401(k) plan are required to have a dual eligibility requirement under which an employee must complete either a one year of service requirement (with the 1,000-hour rule) or three consecutive years of service where the employee completes more than 500 hours of service. For employees who are eligible solely by reason of the new rule, the employer may elect to exclude them from receiving employer contributions. This particular provision will impact plan years beginning after Dec. 31, 2020.
Penalty-free retirement plan withdraws for birth or adoption purposes
This particular provision creates a new waiver from the penalty on pre-mature retirement plan distributions used for childbirth or adoption expenses up to $5,000. This limit is for each individual, so it would be possible for each spouse to request a $5,000 distribution from his/her respective plan or IRA for each birth or adoption. The distribution must be made during the one year period beginning the date the child is born or the date the adoption is finalized. This distribution may be taken from an IRA or qualified employer plan.
As you can see, the SECURE Act has made sweeping changes to the retirement planning landscape, and the full scope of these changes and their implications have yet to be discovered. Contact a member of our team today for clarification and more information.
By Paul McEwan, CPA, MTax, AIFA (New Philadelphia office)