Opinions January 10, 2023

Time for SECURE 3.0

America has a retirement crisis, and SECURE 2.0 takes some important steps to address it, but they are not enough. 

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In late December 2022, Congress and the White House passed the legislation that has been nicknamed SECURE 2.0. There is much to celebrate but, once the victory lap is over, there is much more to be done.

America has a retirement crisis, and SECURE 2.0 takes some important steps to address it. It allows people to save longer in defined contribution retirement plans before required minimum distributions kick in. It allows older participants to make larger “catch-up” contributions, and it increases the possibilities for rolling an account from a prior employer’s 401(k) into a new employer’s 401(k). These are important, but they are not enough. At least three additional changes should be part of SECURE 3.0.

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First, SECURE 2.0 requires employers that offer a new DC plan to auto-enroll employees at a contribution rate of at least 3%, rising to 10% over time. This is a tremendous step forward. However, it does not apply to existing DC plans started before 2020, and it does not require that the employer actually offer any workplace retirement plan at all.

Many states, including Oregon and California, have adopted legislation that does require workplace retirement plans: Employers must either provide one or enroll employees in a state-run plan. Similar legislation has recently been introduced in Congress, designed by Teresa Ghilarducci, a Democrat and professor at the New School for Social Research and Kevin Hassett, a Republican and former chair of the White House Council of Economic Advisors. This legislation would allow employers to set up their own 401(k)s as they do now, but if an employer does not provide a 401(k), then it would be required to assist in enrolling the employee in a plan similar to the Federal Thrift Savings Plan—essentially the defined contribution plan for federal government employees.

Republicans may blanch at the idea of a mandate, but the actual inconvenience to the employer is minimal, whereas the benefit to the employees is quite powerful, especially to lower paid employees. If the incentive to save is based on a tax incentive, as it is with IRAs and 401(k) plans, then that incentive is far less valuable to someone who earns less. Instead of an incentive to join the DC plan, the employee is automatically enrolled in it. She can opt out if she wishes to, but the place to begin is with auto-enrollment. This would mean people at the bottom of the economic ladder would begin to build wealth.

However, there is a flaw in the DC model. That is where the second part of SECURE 3.0 should come in. The flaw in the DC model can be found in the name: defined contribution plans. The purpose of 401(k) and other DC plans is not contributions, and it is really not even savings. The real point is income in retirement. DC plans are great at accumulation, but they are not well-designed for decumulation.

Besides requiring auto-enrollment, the law should require that employees be enrolled in a plan that provides guaranteed lifetime income—just like the defined benefit pension plans of old. Guaranteed lifetime income solutions allow employees to take advantage of the same powerful tool that made defined benefit pension plans work: the power of pooling.

We pool risk all the time: auto insurance, health insurance, life insurance. But we do not pool the risk of outliving our savings. In a defined benefit pension plan —and in the kind of guaranteed lifetime income solution we are discussing here—the people who die early subsidize the people who die late. That is the power of pooling. If an employee doesn’t want the lifetime income benefit, he can opt out. But this is where the discussion should begin: “Hello, new employee, and welcome. You are enrolled in our DC plan that provides lifetime income. If you want something else, you are free to opt out.”

Finally, DC plans should be permitted to invest in alternative assets. Technically, they are permitted to do so under current law. But plan sponsors fear litigation over fees and appropriateness, and the market seems to expect daily liquidity and daily valuation. The Department of Labor has issued regulatory guidance that these assets are permitted, but the guidance has been contradictory, politicized and confusing. Nothing works like black letter law.

Why does this matter? Alternative assets can provide much-needed diversification in an investment portfolio. That can mean greater returns or less risk or a combination of both. These investments would not be chosen by individuals, but they could be added professionally to target date funds, which is where the majority of DC assets are now invested.

Corporations that have defined benefit plans are permitted to use these alternative assets to potentially increase returns and decrease required contributions to the pension. Wealthy individuals are also able to invest in alternative assets. But the working-class employee who needs the DC plan to provide income in retirement is essentially denied the use of this important investment alternative.

Additionally, there are far fewer publicly traded companies today than there were 20 years ago. Since the late 1990s, the number has dropped by 25%, making the investable universe smaller and inherently less diversified. Congress needs to make it clear that DC plan participants and their target date funds are permitted and encouraged to include these kinds of investments.

The original SECURE Act, as well as SECURE 2.0, were passed nearly unanimously. Congress knows that retirement reform is desperately needed. These proposals may not receive unanimous support, and they will surely be negotiated along the way. But let’s keep the momentum going and make sure that SECURE 3.0 is quickly developed and includes these necessary reforms.

Charles E.F. Millard, New York, serves as a senior adviser for Amundi US. He is a former director of the U.S. Pension Benefit Guaranty Corporation. This content represents the views of the author and not necessarily those of Amundi US.

This feature is to provide general information only, does not constitute legal or tax advice and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Institutional Shareholder Services Inc. (ISS) or its affiliates.

Compliance January 9, 2023

Plan Creation in a Post-SECURE 2.0 World

SECURE 2.0 creates new tax credits and requires automatic features that will shape plan creation going forward.

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Updated with clarification

Retirement plan advisers specializing in new plan creation will have busy times ahead. Many of the reforms in the SECURE 2.0 package are focused on new plans, with a goal both of spurring more employers to offer retirement benefits, as well as boosting participation among American workers.

Passed in December 2022, the SECURE 2.0 legislation, which builds on the Setting Every Community Up for Retirement Enhancement Act of 2019, uses the very first provision, Section 101, to require automatic enrollment and escalation for new plans. Mark Iwry, a non-resident senior fellow at the Brookings Institution and a former senior adviser to the Secretary of the Treasury, believes lawmakers “by putting auto-enrollment first in the legislation are making a statement,” and these features are “among the main drivers of the bill.”

Automatic Features

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Starting in 2025, newly created retirement plans will be required to enroll their qualified employees at a contribution rate between 3% and 10% of pay. Plan sponsors must then escalate the contribution rate by 1% annually until it reaches a minimum of 10% or a maximum of 15%, at the discretion of the sponsor. A participant may choose to opt out of this structure and select different rates, but absent an expressed preference, sponsors must follow the automated structure as the default. Naturally, plans that begin at a 10% rate could stop at 10% and not auto-escalate, since that would be in compliance with both ranges.

Plans started before 2023 will be grandfathered and will not require any changes to auto enrollment or escalation. Plans made in 2023 or 2024 must have these automatic features but have until 2025 to implement them.

Though future regulations may provide for more flexibility on the increments by which contributions escalate, such as a 2% increase instead of 1%, the statute currently says these annual increments must be exactly 1% (unless a participant elects a different amount).

Iwry says it is not odd that Congress would specifically select 1% increments. He notes that 1% is the most common practice for plans that already use auto-escalation voluntarily, and that while 2% can be a reasonable auto-increase for many employees, Congress might have thought it was a bit ambitious as a default for all future plans, especially for lower income workers. He also says Congress was specific in the ranges it set for automatic enrollment, and so declining to set an auto-escalation range should not be read as an oversight, but instead reflects an intention to require default escalation increments of 1%.

Since Congress declined to set an escalation range in the same section in which they purposefully set enrollment ranges, Iwry thinks it unlikely that future executive regulations interpreting the new legislative requirement would permit default escalation increments at other percentages. He also explains that if a plan considers 1% to be too modest, then they are free to start their auto-enrollment at relatively high percentages, and if 1% is too aggressive, at relatively low percentages.

Automatic enrollment could potentially cause more accounts to get lost, since some employees who never would have started a plan may not remember they have one. Experts say, however, that this is a very small price to pay for the gains of increased enrollment, and the new SECURE 2.0 “Lost and Found” provision, which requires the Treasury Department to create a database of plans for the purpose of matching lost accounts with their participants, should mitigate this risk even further.

Iwry asks “would you rather have 10 people auto-enrolled into accounts they wouldn’t have had otherwise, even if one of them forgets they had an account, as opposed to five people signing up for accounts?” He calls this criticism of auto-enrollment a “red herring.”

Kristen Carlisle, vice president and general manager of Betterment at Work, concurs and adds that this provision also “helps educate the existing plans on the importance of automatic enrollment.” She says some recordkeepers provide incentives to auto-enroll, since that is often more cost effective for them than customized plans, which are costlier to administer. Auto-enrollment also protects employers from certain compliance tests such as non-discrimination testing, since it typically includes more employees who do not qualify as highly compensated.

Allison Brecher, the general counsel at Vestwell, says that participants can opt out of both requirements, and they also have 90 days after the date of their enrollment to request a “permissive withdrawal,” which would refund any contributions they had made up until that point.

Tax Credits

Currently, the three-year tax credit for small businesses with 50 or fewer employees creating a new plan is equal to 50% of administrative costs up to an annual cap of $5,000. SECURE 2.0 increases that credit to 100% of administrative costs.

SECURE 2.0 also clarifies that this credit applies to employers who join a pooled or multiple employer plan that already exists. This provision applies retroactively for plans started after December 31, 2019. Iwry says it is “telling that it is retroactive.” He explains that many small employers who joined MEPs after SECURE 1.0 should have had access to this tax credit. They may have to amend their returns, but now the startup credit is available to recently created plans that joined MEPs, as well as new ones.

Some of the standard costs covered under the start-up credit include buying services from plan providers and educating employees about the plan, Iwry says.

SECURE 2.0 also provides a start-up tax credit specifically for defined contribution plans sponsored by employers with 50 or fewer employees, which phases out gradually as employee numbers grow to between 51 and 100. For the first two years after plan creation, sponsors will receive a tax credit equaling 100% of their matching contributions, followed by 75% in the third year, 50% in the fourth year and 25% in the fifth year. This credit is capped at $1,000 per employee.

Carlisle says these credits are “another step in the right direction” and should be especially helpful to small businesses in plan adoption. Small businesses employ many workers but often do not have the resources to start plans. Carlisle notes that although these tax credits now exist, many businesses, especially small businesses, are unaware of these incentives, and more attention should be paid to raising awareness.

SECURE 2.0 actually does contain provisions related to awareness, one of which is the allocation $50 million to the Department of Labor to raise awareness for employee stock ownership plans.

Brecher also highlights some regulatory changes designed to make plan creation easier. SECURE 2.0 removes the requirement to send out notices to former employees, since keeping contact information on everyone who a sponsor used to employ can be tedious and time-consuming. Also, starting in 2024, plans can transfer the balance of an account worth up to $7,000 from a plan into an IRA, an increase from the previous maximum of $5,000. This provision can help plans near the 100-participant threshold for large plan audits to stay under that cap, which is intended to reduce the compliance burden on those small employers.

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