2020 A Time to Focus on SECURE Act Incentives
Aptly named the SECURE Act, a law passed by Congress in the waning days of 2019 seeks to help Americans enjoy greater financial security in retirement. The Act contains a wide-ranging set of provisions. While some await the development of implementing regulation, others are immediately available for employers’ consideration and offer benefits for both their organizations and employees.
Much has been said about the inadequate retirement savings of Americans. Some estimates suggest individuals should be saving 15 percent of their compensation to supplement expected future income sources, such as Social Security.
Two best plan design practices for 401(k) plans to increase retirement savings are automatic enrollment and automatic escalation. While larger plans frequently include these features, the SECURE Act incentivizes smaller employers to implement automatic enrollment (with smaller employers defined as those with 100 or fewer employees receiving compensation of $5,000 or more). Importantly, the Act permits all employers to increase escalation limits.
- For small employers whose plans are without automatic enrollment, implementing this plan design feature in 2020 or after provides a $500 per year tax credit for three years after implementation.
- Plans that include automatic escalation beginning in 2020 may raise their default percentage to as much as 15 percent in any year after the first full year in which an employee’s compensation is automatically deferred into the plan. (Previously, deferrals could be automatically escalated no higher than 10 percent.)
Automatic enrollment makes it easy for employees to take advantage of the 401(k) plans their employers offer, and automatic escalation can facilitate a meaningful level of savings to their benefit. Here’s how each works:
- Automatic Enrollment – Plans with this feature begin deferring a plan-defined percentage of an employee’s pay once the employee achieves eligibility and reaches the plan’s entry date. The employee is notified of the automatic enrollment and may opt out, change the deferral percentage or accept the automatic enrollment.
- Automatic Escalation – Participants who accept automatic enrollment will have their deferral rates escalated annually until they reach a “limit.” The escalation and the “limit” will be set by the employer as the 401(k) plan is designed. As is the case with automatic enrollment, participants will be notified of the escalation and may opt out or choose an alternate deferral rate.
Just as Congress recognized the need for meaningful retirement savings by increasing the allowable escalation default limit, so employers whose plans currently include automatic features will want to consider whether their defaults are optimum for plan participants. Average automatic enrollment defaults are 3 percent, far lower than the recommended 15 percent savings goal. When plans escalate deferrals, it often is only 1 percent annually. Optimally, employers should consider changes for the next plan year of at least a 6 percent initial deferral and a 2 percent escalation rate. While some employers fear higher opt-out rates will accompany higher defaults, experience shows little difference between plans with lower and higher deferral rates.
Automatic features encourage savings for employees with a 401(k) plan in their workplace. Seeking to provide greater access to workplace retirement plans, Congress increased the tax credit for small businesses adopting a plan after January 1, 2020 to a maximum of $5,000 for up to three years. (Again, a small employer is one with 100 or fewer employees receiving compensation of $5,000 or more.)
By incentivizing best practices in 401(k) plans and promoting greater retirement savings, provisions of the SECURE Act create a winning combination for employers and employees.
This blog is written to help make the lives of plan sponsors easier in the process of meeting legal requirements under ERISA for their defined contribution plans. Please understand that reading this blog should not alone take the place of a one-on-one consultation regarding the needs of your specific plan and hence cannot be a guarantee against fiduciary breaches.