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Unpacking SECURE 2.0

Unpacking SECURE 2.0

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SECURE 2.0 is finally here! Signed into law on December 29, 2022, the new legislation contains a raft of incremental reforms that have the potential to further enhance retirement security for many Americans.

While the law’s most significant provisions aim to greatly expand access to retirement programs to those who currently lack it, there are a number of provisions that affect current defined benefit (DB) sponsors and participants – including corrections, streamlining of current rules, and expansion of measures seeking to protect and inform participants.

Welcome relief

The highlight of SECURE 2.0 for defined benefit plan sponsors is the freeze of the variable premium rate set by the Pension Benefit Guaranty Corporation (PBGC) at $52 per each $1,000 of unfunded vested liability.

Before this change, the rate for this premium increased with inflation, leading to unreasonably burdensome premiums that would have gone beyond the needs of the system. This had been a sore point among plan sponsors and correcting this imbalance provides welcome relief starting next year.

New life to cash balance plans

Also changing is how cash balance plans that credit interest at variable (market-based) rates project future benefits for the purpose of demonstrating that the anti-backloading rules are satisfied. The new provision allows the use of a reasonable projection of the plan’s future interest crediting rate (up to 6%) to determine the interest credit, instead of using the current year’s market-based rate without any cap as the basis for projecting such rates.

In the past, to account for the possibility that the rate could decline and cause the plan to fail the anti-backloading test, plans would often incorporate a fixed-floor interest rate. This created a disconnect with market rates and made the liability much more difficult to hedge with commonly available investments. The alternative was to design the plan with smaller pay credits for older employers with more service. That way, the plan wouldn’t fail the anti-backloading tests in a low-interest environment. But this resulted in a plan that was much less generous to those employees than some plan sponsors desired.

This change may give new life to cash balance designs, which had promised a best-of-both-worlds approach to DB/DC plans but have been held back from fulfilling their potential by technical hurdles.

Overpayment protections

There are also a number of updates to plan administration rules in SECURE 2.0, including an update to the rules that govern the correction of inadvertent overpayments made to participants.

Plan fiduciaries are still permitted to take reasonable steps to recoup any overpayments from participants and beneficiaries, but effective immediately, a plan fiduciary may, in its discretion, choose not to recover all or part of the overpayment. In the event a recovery is sought, the act provides additional protections to the participant, including limiting the reduction of future payments to 10% of the corrected payment amount, and requiring a participant to be notified of an overpayment within 3 years of the first overpayment if a recoupment is to be pursued. The act also prohibits interest or additional amounts (such as collection costs) from being included in the overpayment amount.

Expanded disclosure requirements

Continuing the theme of participant protections, the act also introduces expanded notification requirements for DB plans that offer “lump sum windows”, which are limited time offers to cash out the full value of a participant’s plan benefit in the form of a lump sum.

The notice requirements include plain-language explanations to participants and beneficiaries at least 90 days before the window opens about how the lump sum is calculated, including whether any early retirement subsidies have been included, and any other options. Potential risks associated with taking a lump sum and giving up access to an annuity also need to be made clear. Special filings with the DOL and PBGC about the window must also be made 30 days before the window opens and 90 days after it closes.

This provision will not apply until final IRS regulations go into effect, which cannot be any earlier than December 29, 2024.

Also related to participant communications, the Annual Funding Notice to DB plan participants will be enhanced to use the funding ratio without regard to funding balances. Plan sponsors will need to clarify some of the plan funding issues, such as explaining that the funded status used by PBGC to determine whether the plan’s assets are sufficient to pay vested benefits in excess of the PBGC guarantee at plan termination is generally lower than the disclosed funded status. These changes are effective for plan years beginning after December 31, 2023.

The impact of improved longevity

Mortality has also been a matter of interest for regulators and plan sponsors. The valuation of pension plans involves estimating mortality rates as accurately as possible, as the longevity of plan participants is one of the most significant factors in determining the ultimate cost of the plan.

Advancements in medicine, improvements in living conditions, safety standards and so on have led to significant improvements in mortality rates over the years; continuing efforts on all of those fronts will very likely lead to more mortality improvements. However, the rate at which those improvements will occur defies prediction and is subject to debate. The COVID-19 pandemic and questions surrounding its future impact have added to the uncertainty.

Perhaps in response to the pandemic, or through a desire to better align with the projections of the Social Security Administration, Congress included a provision in SECURE 2.0 to limit the rate at which mortality is projected to improve. It also directs the IRS to keep this rate updated in the future through regulation based on the improvement rate projected by the Social Security Administration.

It is not entirely clear how the rate will be applied to existing mortality improvement scales, but it should generally have the effect of reducing pension liabilities. The IRS is called to release regulations not later than eighteen months after enactment to apply the new rule which will be effective for valuation dates during or after 2024.

Retiree health accounts

The last item to highlight is an enhancement of rules allowing the transfer of excess pension assets to retiree health accounts.

The current rules allow for transfers in a plan year from a pension plan that is more than 125% funded to a health benefits account or an applicable life insurance account set up under Section 420 of the tax code for the purpose of paying those health and life insurance benefits.

These transfers were set to sunset on December 31, 2025, but SECURE 2.0 has extended this date to December 31, 2032. Further, it introduces a special rule for de minimis transfers which don’t exceed 1.75% of the applicable asset value (less funding balances) in non-collectively bargained plans. Under these rules, the plan only needs to be at least 110% funded to make the transfer.

SECURE-ing opportunities

Now that SECURE 2.0 is here, there is work to be done and opportunities to evaluate. The associated study and regulation delegated to the agencies will bring the full effect of the measure into focus over the coming months. Defined benefit plan sponsors should work closely with their advisors to make sure they are aware of these opportunities and are complying with the new requirements.

 

This article is for information only and does not constitute legal advice; consult with legal, tax, and other advisors before applying this information to your specific situation.