A SECURE 2.0 update, plus 401(k) pitfalls to avoid
As you may have heard, President Joe Biden signed SECURE 2.0 into law in late December as part of the Consolidated Appropriations Act, 2023. Our experts are reviewing the details of the new law, which makes significant changes to the retirement plan landscape to include expanding automatic enrollment, increasing required minimum distribution ages, allowing matching contributions to be made on student loan payments, and improving 401(k) plan coverage for part-time employees.
We will provide more SECURE 2.0 details in the coming months, including a webinar for clients in the first quarter of 2023.
Other than the late year passage of SECURE 2.0, it was a quiet quarter in terms of proposed legislation. As such, we decided to use this space to focus on three common 401(k) pitfalls plan sponsors must navigate.
Pitfall #1: Late deferrals
When an employer withholds elective deferrals (or loan payments) from a participant’s paycheck, the deferrals must be timely transmitted to the plan’s trust. Failure to do so can result in an excise tax under the prohibited transaction rules, and perhaps more importantly, may trigger a Department of Labor (DOL) audit.
For small plans (those with fewer than 100 participants at the beginning of the plan year), elective deferrals should be transmitted to the plan’s trust no later than the seventh business day following the day the amount would otherwise have been payable to the participant in cash.
For large plans (those with 100 or more participants at the beginning of the plan year), deferrals must be transmitted to the plan’s trust as soon as possible. For example, if deferrals can be transmitted to the plan’s trust within three business days, but deferrals are not transmitted to the trust until the fourth business day, the DOL will likely assert that the failure to transmit the deferrals by the third business day is a prohibited transaction.
Pitfall #2: Eligibility for rehired employees
Plan sponsors often ask us how the eligibility rules apply to rehired employees. If the rehired employee did not previously satisfy the eligibility requirements, they must first satisfy the eligibility requirements to be a participant. However, if the rehired employee previously participated in the plan, then in most cases, the rehired employee must enter the plan immediately upon their rehire date. Here’s an example that illustrates how most plans address eligibility when a rehired employee previously participated in the plan.
- At XYZ Inc., an employee must complete one year of service to be eligible to participate in the plan. This employee completed a year of service and was a plan participant when she terminated employment on March 7, 2017. She was rehired on May 1, 2022. Having previously participated in the plan in her first period of employment, the employee will begin participating in the plan immediately on her 2022 rehire date.
It’s worth noting that different rules may apply if the employer amended the plan’s eligibility requirements between the employee’s employment periods, or if the employee did not become a participant in the plan during the first employment period. As your plan may be different, feel free to contact your UBT Relationship Manager with any questions about how the eligibility rules apply to a rehired employee.
Pitfall #3: Hardship distributions
If a plan allows hardship distributions, the participant must document both the purpose for the distribution and the amount needed to satisfy the hardship. Let’s take a closer look at these two cases.
Proper purpose. A hardship distribution is available to pay a defined list of expenses, including:
- Medical expenses for the participant, spouse, dependents, or primary beneficiary
- Costs to purchase a principal residence for the participant
- Post-secondary tuition, educational fees, and room and board for the participant, spouse, children, or primary beneficiary
- Amounts needed to prevent eviction or mortgage foreclosure on the participant’s principal residence
- Burial or funeral expenses for the participant’s deceased spouse, parent, children, or primary beneficiary
- Expenses to repair damage to the participant’s principal residence that would qualify as a casualty deduction
- Expenses and losses incurred by the participant as a result of a FEMA-declared disaster.
The participant must provide documentation (e.g., bills or statements) to the Plan Administrator, showing the distribution is for one of these purposes.
Amount needed to satisfy financial need. The distribution cannot exceed the amount needed to satisfy the financial need, but can be grossed up to pay taxes and penalties that may result from the distribution. The participant must provide bills or statements to the plan administrator, showing the amount needed to satisfy the need. For example, assume burial expenses are $10,000. The participant expects to incur taxes and penalties of $2,500 in connection with the distribution. The participant submits a bill showing the $10,000 of expenses. The plan can make a $12,500 hardship distribution — grossed up to pay taxes and penalties — to the participant.
If you have any questions about these common 401(k) plan errors or about your plan, please contact your UBT Retirement Plan Services Relationship Manager.
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