On June 22, 2022, the Senate Finance Committee reported out the Enhancing American Retirement Now (EARN) Act by a vote of 28 – 0. The bill now goes to the full Senate where it is expected to be combined with a companion piece of legislation reported out by the Senate Committee on Health, Education, Labor and Pensions, known as the Rise and Shine Act (Retirement Improvement and Savings Enhancement to Supplement Healthy Investments for the Nest Egg Act).
Once legislation is actually enacted by the Senate, it will need to be reconciled with the Securing a Strong Retirement Act of 2022 (H.R. 2954), also known as the SECURE Act 2.0, recently passed by the House of Representatives.
Prior to the hearing, the Senate Finance Committee prepared a summary of the provisions of the EARN Act. The Committee’s summary contains ten sections with a total of seventy separate paragraphs. We do not have the time or space to discuss each provision. The following is a description of some of the more important provisions.
A. Individual Retirement
1. Secure Deferral Arrangements
401(k) plans, like all qualified retirement plans, are subject to nondiscrimination testing. A plan that automatically enrolls employees into elective deferrals and requires certain mandatory employer contributions is treated as having passed nondiscrimination testing. Under current law, the default employee deferral must be no less than 3% in the first year and must increase by at least 1% in each subsequent year until it reaches at least 6%. In addition, the employer matching contribution must be equal to at least 100% of the first 1% deferred by the employee and 50% of the next 5% deferred. Or, the employer can make a contribution of 3% of an employee’s compensation even if the employee does not make a deferral.
The proposed legislation provides an alternate method of satisfying nondiscrimination testing. It requires that default deferrals be no less than 6% in the first year and increase by 1% in each subsequent year reaching 10% by the fifth year. It further requires employer matching contributions of 100% of the first 2% of deferrals, 50% of deferrals between 2% and 6% of compensation and 20% of the next 4% of deferrals.
This provision would be effective for plan years beginning after December 31, 2023.
2. Matching Payments
Under current law, certain taxpayers may claim an income tax credit for contributions made to an IRA or certain employer-sponsored retirement plans, such as a 401(k) plan. The credit is nonrefundable, which means that it is available only to employees who otherwise would have a tax liability.
The proposed legislation changes this credit from one that is a tax refund to one that is paid as a matching contribution by the government into the employee’s retirement account, whether an IRA or a 401(k) account. The amount of the credit is 50% of an employee’s contribution up to $2,000. The credit is phased out for income between $20,500 and $35,500 for single taxpayers ($41,000 and $71,000 for taxpayers filing joint returns.)
This provision would be effective for plan years beginning after December 31, 2026.
3. Part-Time Employees
Prior to the enactment of the SECURE Act of 2019, an employer was not required to include part-time employees in its qualified retirement plan. The SECURE Act of 2019 changed the law. Under current law, a part-time employee who has worked at least 500 hours for three consecutive years must be allowed to participate in the employer’s 401(k).
The proposed legislation would reduce the 3-year requirement to two years.
This provision would be effective for plan years beginning after December 31, 2022.
4. Student Loans
This provision of the EARN Act matches the corresponding provision of the House-passed SECURE Act 2.0. It permits employers to provide matching contributions to employees making student loan payments as if those loan payments were elective deferrals. The employer matching contribution must be the same percentage for student loan payments as for elective deferrals.
This provision would be effective for plan years beginning after December 31,2023.
5. Hardship Withdrawals
Under current law, a 10% penalty is imposed on early withdrawals from a qualified retirement plan. Early withdrawals are those that occur before age 59 and ½.
The proposed legislation would provide an exception to the early-withdrawal penalty. The penalty would not apply to withdrawals for emergency expenses, which are defined as “for the purpose of meeting unforeseeable or immediate financial needs relating to necessary personal or family expenses”. An employer can rely on the employee’s certification that the withdrawal is for an emergency personal expense. An employee would be limited to one withdrawal per year in an amount up to $1,000. An employee may repay the distribution over a three-year period. No further distribution would be allowed until the outstanding distribution has been repaid.
This provision would be effective for distributions occurring after December 31, 2023.
6. Incentives for Participation
Under current law, an employer may not provide a financial incentive to an employee to participate in the employer’s qualified plan. The proposed legislation would permit an employer to provide a “de minimis financial incentive” to an employee in addition to the employer’s matching contribution. The term “de minimis” does not appear to be defined in the proposed legislation.
This provision would be effective for plan years beginning after the date of enactment.
7. Catch-Up Contributions
The “catch-up” provisions of the EARN Act are similar to the corresponding provisions of the SECURE Act 2.0. Under current law, any individual who is 50 years or older can make a catch-up contribution to an IRA in the amount of $1,000. That amount is not currently indexed for inflation. For plan years beginning after the date of enactment, the catch-up amount will be indexed for inflation.
Like the SECURE Act 2.0, the EARN Act also increases the catch-up amount that certain employees can contribute to their 401(k) accounts. The current catch-up amount is $6,500 for employees over the age of 50. Under the proposed legislation, employees who turn 60, 61, 62 or 63 after December 31, 2023, will be able to increase their catch-up contribution to $10,000, indexed for inflation. The ages at which an employee can take advantage of this enhanced catch-up contribution is slightly different in the EARN Act than in the SECURE Act 2.0.
B. Retirees
1. Increase in Age for Required Minimum Distributions
Under current law, participants in a qualified retirement plan are required to begin taking distributions from the plan by April 1 of the calendar year after the later of the calendar year in which the plan participant attains age 72 or retires.
The proposed legislation increases the age of mandatory distributions to 75 beginning in 2031. So, an employee who turns 72 in 2032 is not required to take a minimum distribution for that year, even though the employee turned 72. This proposal is slightly different than that contained in the SECURE Act 2.0. Under the SECURE Act 2.0, there was an intermediate increase in the age of mandatory distributions and the applicable age did not reach 75 until after December 31, 2033.
This provision would be effective for calendar years beginning after the date of enactment.
2. Long-Term Care Insurance
The proposed legislation would permit distributions from a qualified retirement plan to pay premiums for long-term care insurance. The distribution is limited to $2,500 per year and would not be subject to the 10% penalty on early withdrawals. This provision is limited to “high quality coverage”, which is defined as a policy that would provide meaningful financial assistance for home-based or nursing home care.
This provision would be effective for distributions made three years after the date of enactment.
C. Employer Plans
1. Employer Credit
A small employer that adopts a “Secure Deferral Arrangement”, as described in section A.1. of this memorandum, is eligible for a tax credit. The term “small employer” means an employer with 100 or fewer employees. The amount of the credit is equal to the employer’s matching contributions for each employee up to 2% of the employee’s compensation. The credit is available for the first 5 years of the employee’s participation in the plan. There is no credit for employer contributions made on behalf of highly-compensated employees.
This provision would be effective for tax years which include any portion of a plan year beginning after December 31, 2023.
2. Start-Up Credit
The Code currently provides a credit to certain employers that adopt a qualified retirement plan to help subsidize start-up costs. The current credit is 50% of the administrative costs for the first three plan years up to a maximum of $5,000 per year. The EARN Act increases the credit to 75% for employers with fewer than twenty-five employees. This provision is not as generous as the corresponding provision in the SECURE Act 2.0. Section 102 of the SECURE Act 2.0 increases the credit for employers with 50 or fewer employees to 100%.
This provision would be effective for tax years beginning after December 31, 2023.
3. Starter 401(k) Plans
The proposed legislation creates a new type of 401(k) plan – the Starter 401(k) Deferral-Only Arrangement” – for employers that do not maintain another qualified plan. Under this plan design, all employees who are eligible to participate must be treated as having elected to make deferrals to the plan in the percentage established by the plan. An employer may only exclude employees who have not attained the permitted age and service requirements; although an employer may also exclude employees subject to a collective bargaining agreement.
The percentage of deferral must be at least 3% and may be no more than 15% and must be applied uniformly to all employees. An employee may opt-out of the plan or may elect a different deferral percentage. In a Starter 401(k) Deferral-Only Arrangement, only employee contributions are allowed. An employer may not make matching contributions. The limit on contributions is $6,000, plus $1,000 in catch-up contributions for employees who have attained age 50. These amounts will be adjusted for inflation.
This provision would be effective for plan years beginning after December 31, 2023.
As stated at the beginning of this article, the EARN Act has been reported out of the Senate Finance Committee. A companion piece has been reported out of the Senate Committee on Health, Education, Labor and Pensions. These two bills need to be reconciled and passed by the entire Senate. At that point, the legislation has to be reconciled with the SECURE Act 2.0 passed by the House in March. And, then, the resulting bill has to pass both the House and Senate before it becomes law. While there is great optimism that something will get done this year, until both chambers of Congress actually pass the same bill, we won’t know what changes to current law will actually be made.
