IRS Grab Bag Notice Provides Guidance on Several SECURE 2.0 Items

Updated with Correction

The IRS issued an 81-page question-and-answer notice related to several provisions of the SECURE 2.0 Act of 2022 that became law almost exactly a year ago. The document is titled “Miscellaneous Changes Under the SECURE 2.0 Act of 2022.”

The notice provides clarity on automatic features, tax credits, de minimis incentives, Roth matching contributions, withdrawals related to terminal illness and other features.

The notice does not speak to other provisions on which the retirement industry has sought guidance, such as mandatory Roth catch-up contributions for highly-compensated employees, student loan matching or emergency savings accounts.

Automatic Features

Section 101 of SECURE 2.0 requires defined contribution plans that are created after the law was enacted on December 29, 2022, to have automatic enrollment and deferral features starting on January 1, 2025. Specifically, plans must enroll participants at contribution levels of between 3% and 10% of salary and escalate by 1 percentage point per year until their rate is between 10% and 15%, unless the participant opts out or elects other contribution levels, which they must be free to do.

The notice clarified that the start date for purposes of automatic features is when the initial plan document is adopted, even if the start date is at a later point. An example provided in the notice detailed that if a plan document was adopted on October 3, 2022, but has a start date of January 1, 2023, then it is not considered subject to the automatic requirement come 2025.

Additionally, if a plan that was grandfathered in merges with a plan that is subject to Section 101, then the ongoing plan is not grandfathered in and must adopt automatic features.

Tax Credits

Section 102 provides for two tax credits related to DC plans. The first provides a tax credit to cover 100% of plan start-up expenses, up to a maximum of $5,000 annually for the first three years of the plan, for employers with 50 or fewer employees.

It also provides a credit for employer matching contributions for employers with 100 or fewer employees, with the credit phasing out gradually for employers with 51 to 100 employees. The credit covers 100% of the match for the first two years of the plan, decreasing by 25% each year until it is zero in Year 6.

The notice clarifies that these are two separate credits that should not be read in a way that makes them exclusive with each other.

Further, in order to qualify for these credits, the employer must have been eligible in both the year it claims the credit and the first year of the plan. For example, an employer with 101 employees in the first plan year cannot lay an employee off to become eligible.

If a plan was created before the law passed, the sponsor is eligible for the credit too, but only for the remaining time. A plan created in 2022, for example, could claim two years of start-up tax credits and four years of employer contribution credits.

De Minimis Incentives

Section 113 permits employers to give their employees small “de minimis” financial incentives to join retirement plans. These incentives can include cash or cash replacements, such as gift cards, and cannot be paid out of plan assets. The notice clarified that the maximum value these incentives can be is $250, and it is considered taxable income.

Further, these incentives can only be given to those not already in the plan as a way to get them to join. However, the notice elaborates that an incentive that “is provided in the form of installments that are contingent on the employee’s continuing to defer” are legitimate as well.

An example in the notice specified that an employer could give a $100 gift card for joining a plan and another $100 card a year later if the participant remains in the plan.

Terminal Illness

Section 326 permits a terminally ill individual to withdraw early from their retirement account without being subject to the 10% tax penalty.

The IRS clarified that for these purposes, “a terminally ill individual means an individual who has been certified by a physician as having an illness or physical condition that can reasonably be expected to result in death in 84 months or less after the date of the certification.”

The notice also outlined the items that the certifying physician must include in the certification, which include a narrative description of the evidence on which they are relying. Plans may not rely on self-certification from participants for this provision.

Permitting distributions for terminally ill individuals is an optional benefit that plans can offer, meaning they are not required to update plan documents and process such distribution requests if they chose not to.

However, according to the notice, if the terminally ill participant withdraws money from the plan, that participant may still report it as a terminally ill distribution on their tax return to avoid the penalty. The participant should retain the doctor’s certification in the event the IRS asks to see it. In this case, the distribution would still be taxed as gross income, but the 10% penalty would not be imposed.

Roth Matching

Section 604 permits plans to make employer contributions on a Roth basis. This means that an employee would pay income tax on a match in order to receive it as after tax.

Since many plans have vesting schedules, this provision created uncertainty about taxation and vesting. The notice clarified that an employee may not designate employer contributions as being from a Roth source if the participant is not fully vested: “A matching contribution may be designated as a Roth contribution only if the employee is fully vested in matching contributions at the time the contribution is allocated to the employee’s account.”

According to the notice, the contributions made this way are to be added to the taxable income in the year in which the contribution is made into the participant’s account, even if the contributions are paid by the sponsor in the prior year.

The clarification is intended to avoid the problem of a participant electing a Roth match, paying taxes on that match and then having those contributions revoked before they are vested.