New guidance answers questions for retirement plan sponsors

In late December 2023, the Internal Revenue Service provided additional guidance in the form of questions and answers (“Q&As”) with respect to certain key qualified retirement plan provisions of the Consolidated Appropriations Act, 2023, known as the SECURE 2.0 Act of 2022 (“SECURE 2.0”).

For 401(k) plan sponsors, here are a few items of interest:

1. Small Financial Incentives. Something known as the “contingent benefit rule” has long provided that a plan cannot condition any other benefit (other than matching contributions) on whether an employee makes 401(k) deferrals.  Section 113(a) of SECURE 2.0 changed this to allow an employer to provide a “de minimis” financial incentive to employees to encourage them to make deferrals and save for their retirement.  One question left unanswered by SECURE 2.0 was what that means, i.e., is a “de minimis” financial incentive $50, $500, $5,000, etc.?  The new Q&As answer that by defining “de minimis” as no more than $250.  The Q&As also make it clear that employers cannot give this incentive to employees who are already making 401(k) deferrals.
2. Terminal Illness Distributions. Section 326 of SECURE 2.0 allows a terminally ill individual to receive a distribution from a qualified retirement plan and avoid the 10% early distribution penalty that normally applies to distributions before age 59.5.  For this purpose, a terminally ill individual is someone 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.  The new Q&As provide many additional details regarding these distributions.  Most notably, the Q&As clarify that retirement plans are not required to permit these distributions – AND plans cannot even allow the distributions unless the employee is otherwise eligible for a permissible in-service distribution.  For example, a 401(k) plan may distribute a terminally ill individual distribution to an employee who is otherwise eligible for a hardship or disability distribution.  This is a little weird because SECURE 2.0 thus provides an exception to the 10% excise tax for a distribution that is not, by itself, even allowed.
3. SECURE 2.0 Amendment Timing. The Q&As extend the deadline for plan sponsors to amend their plans for SECURE 2.0.  Non-governmental plans now have until December 31, 2026.  Collectively bargained plans have until December 31, 2028.  And governmental plans have until December 31, 2029.
4. Employer Contributions as Roth Contributions. SECURE 2.0 gives a plan sponsor the option to add a plan provision allowing employees to designate vested employer contributions (e.g., matching contributions) as Roth contributions.  The Q&As provide quite a few details regarding this optional feature, including clarifying that (a) any such employer contributions are excluded from wages under section 3401(a) for purposes of federal income tax withholding; and thus (b) an employee who designates an employer contribution as a Roth contribution may need to increase their withholding or make estimated tax payments to avoid an underpayment penalty.