The SECURE Act 2.0: The Most Impactful Provisions (#4–Optional Treatment of Employer Contributions as Roth Contributions)

Key Takeaways

  • The SECURE Act 2.0 permits plan sponsors to give participants the option of receiving employer contributions on a Roth basis.
  • This provision is effective on the date of enactment, December 29, 2022.
  • However, the option may not be as attractive as it first appears, since the matching and nonelective contributions must be fully vested when made.

The President signed the Consolidated Appropriations Act, which included SECURE Act 2.0, on December 29, 2022.

SECURE Act 2.0 has over 90 provisions, some major and some minor; some mandatory and some optional; some retroactively effective and some that won’t be effective for years to come. One difference between the SECURE Act 2.0 and previous acts is that so many of 2.0’s provisions are optional…that is, plan sponsors are not required to adopt the provisions, but can if they conclude that the change will help the plan and the participants. This series discusses the provisions that are likely to be the most impactful, either as options or as required changes.

This article discusses one of the optional provisions—the ability of plan sponsors to permit participants to elect to receive matching and nonelective employer contributions on a Roth basis, meaning that the contributions would be taxed through to the participant when made, but that the contributed amounts would ultimately be distributed tax free and, if the Roth conditions are satisfied, the earnings would also be tax free. This provision was effective on the date on enactment of SECURE Act 2.0—December 29, 2022.

Continue reading The SECURE Act 2.0: The Most Impactful Provisions (#4–Optional Treatment of Employer Contributions as Roth Contributions)

Share

The SECURE Act 2.0: The Most Impactful Provisions (#3–Extension of RMD Start Ages)

Key Takeaways

  • The SECURE Act 1.0 delayed the starting age for RMDs from 70½ to 72.
  • SECURE Act 2.0 further delays the ages to 73 and 75.
  • As a practical matter, while most plan participants and IRA owners will need to access their retirement savings before those ages, the change creates an opportunity for higher compensated and wealthy individuals to delay the tax consequences of mandatory distributions from plans and IRAs.

The President signed the Consolidated Appropriations Act, which included SECURE Act 2.0, on December 29, 2022.

SECURE Act 2.0 has over 90 provisions, some major and some minor; some mandatory and some optional; some retroactively effective and some won’t be effective for years to come. This series of blog articles discusses the provisions that are likely to be the most impactful.

The first article was about Automatic Plans, a mandatory provision. The second article was about Matching Student Loan Payments, an optional provision.

This article discusses the extension of the starting age for Required Mandatory Distributions (RMDs). The SECURE Act 1.0 delayed the starting age from 70½ to 72. SECURE Act 2.0 further delays those dates. As a result of the changes in those two statutes, the ages for starting RMDs are:  72 in 2022; 73 in  2023; and 75 in 2033.

Continue reading The SECURE Act 2.0: The Most Impactful Provisions (#3–Extension of RMD Start Ages)

Share

The SECURE Act 2.0: The Most Impactful Provisions (#2–Student Loan Matches)

Key Takeaways

  • Some provisions in SECURE Act 2.0 are optional, where plan sponsors can adopt the provision in their discretion. Many of those provisions are opportunities to make plans more attractive or beneficial to employees.
  • One such optional provision is the ability to match student loan repayments, which should be attractive to employers who hire college graduates.
  • The provision is effective for plan years after December 31, 2023.

The President signed the Consolidated Appropriations Act, which included SECURE Act 2.0, on December 29, 2022—the “enactment date”.

SECURE Act 2.0 has over 90 provisions, some major and some minor; some are mandatory and some are optional; and some are retroactively effective and some won’t be effective for years to come. This series of articles will discuss the provisions that are likely to be the most impactful.

Continue reading The SECURE Act 2.0: The Most Impactful Provisions (#2–Student Loan Matches)

Share

The SECURE Act 2.0: The Most Impactful Provisions (#1–Automatic Plans)

Key Takeaways

  • “New” 401(k) and 403(b) plans must be automatically enrolled, with automatic deferral increases, no later than the plan year beginning after December 31, 2024 (e.g., 2025 for calendar year plans).
  • Any plan “established” on or after December 29, 2022 is considered a new plan.
  • Defaulting participants must be invested in a QDIA.
  • There are exceptions for government plans, church plans, SIMPLE 401(k) plans, employers with 10 or fewer employees, and employers during their first 3 years of existence.

The President signed the Consolidated Appropriations Act, which included SECURE Act 2.0, on December 29, 2022—the “enactment date”.

SECURE Act 2.0 has over 90 provisions, some major and some minor. One of the most impactful provisions is the new requirement to automatically enroll and automatically increase deferrals to new 401(k) and 403(b) plans.

New 401(k)s and 403(b)s must be automatically enrolled and the deferrals automatically increased, beginning for plan years after December 31, 2024. At that time, 401(k) and 403(b) plans will be required to automatically enroll eligible employees at 3% (but not more than 10%) and thereafter automatically increase the deferral rates by 1% per year up to at least 10% (and if desired by the employer, up to a maximum of 15%). Defaulting participants must be invested in a QDIA (qualified default investment alternative).

Continue reading The SECURE Act 2.0: The Most Impactful Provisions (#1–Automatic Plans)

Share

PTE 2020-02: The Remaining Steps: Retrospective Review and Correction of Compliance Failures (Part 1)

Key Takeaways

    • The next step in compliance with the DOL’s PTE 2020-02 is to conduct the annual retrospective review for 2022 and to reduce the review to a written report to be signed by a “senior executive officer.”
    • The review and report must be completed within 6 months after the end of the year.
    • In the process of conducting the review, it is likely that compliance failures will be discovered. To avoid prohibited transaction consequences, the failures must be corrected within 90 days of discovery and reported to the DOL within 30 days of correction.
    • The failures and corrections must also be included in the report.
    • There are a number of types of potential failures, some of which may be easy to correct and others of which will be more difficult.
    • Unfortunately, the DOL did not provide any guidance on how to correct failures. As a result, careful thought—with competent legal advice—should be given to the correction methodology.

Now that 2022 is behind us, the final steps in compliance with PTE 2020-02 must be satisfied. Those steps are (i) conducting the annual retrospective review and the resulting report (within six months) and (ii) correcting any compliance failures that are discovered in the course of the review.

The Review and Report are conditions to obtaining the relief afforded by the exemption. In other words, if they are not properly completed the protection is lost and all conflicted recommendations under the PTE are considered to be prohibited transactions. The consequence of having hundreds or even thousands of prohibited transactions is unimaginable. Here’s what the PTE says about the Retrospective Review and Report:

Continue reading PTE 2020-02: The Remaining Steps: Retrospective Review and Correction of Compliance Failures (Part 1)

Share

Discretionary Management of IRAs: Conflicts and Prohibited Transactions

Key Takeaways

  • Where an investment adviser charges different fees for managing fixed income in a portfolio than for managing equities, and has discretion to determine the allocation between the two in an IRA, the investment adviser has control over its fees, which appears to violate a prohibited transaction provision in the Internal Revenue Code.
  • The inadvertent violation can be corrected, going forward, by using a blended rate where both allocations are charged the same fee. In other words, there would just be an account fee and not a fee that varied by allocations that are within the control of the investment adviser.
  • There are other potential solutions, including transitioning the allocations to nondiscretionary advice.

Discussion

Both the Internal Revenue Code (Code) and the Employee Retirement Income Security Act of 1974 (ERISA) include prohibited transaction provisions that literally prohibit certain transactions (unless exempted by statute or by a prohibited transaction exemption). ERISA-governed qualified retirement plans are subject to both ERISA and Code prohibitions. However, standalone IRAs are only subject to the Code prohibitions. In that regard, Code sections 4975(c)(1)(E) and (F) provide:

(c) Prohibited transaction

(1) General rule

For purposes of this section, the term “prohibited transaction” means any direct or indirect—

*****

(E) act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account; or

(F) receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.

In plain English, subparagraph (E) means that a fiduciary adviser cannot manage an IRA’s investments in a way that benefits the adviser beyond the negotiated advisory fee. For example, a fiduciary adviser could negotiate a fee of 1% (or 100 basis points) for managing an equity portfolio and 70 basis points for managing a fixed income portfolio without a problem (so long as the amounts are reasonable for the services rendered). But, when the fiduciary adviser can move money from one portfolio (or part of a portfolio) to another, and the fees are increased by that movement of money, the adviser has dealt with the assets of the “plan” (which includes IRAs) for his own interest. It is even conceivable that the IRS could take the position that, if the fiduciary adviser has discretion to allocate all of the portfolio to fixed income investments, any allocation to equities (with the higher fees) would be a prohibited transaction.

As an extreme example, if the adviser in this hypothetical scenario managed one-half of a portfolio in equities (for a fee of 100 basis points) and one-half in fixed income (for 70 basis points), but then, with unilateral discretion moved the fixed income allocation to equities—thereby increasing the adviser’s fees on those assets to 100 basis points, it appears that the fiduciary adviser would have used its discretion for its own interest or account, which is a prohibited transaction.

Before going further, I should point out that ERISA defines a fiduciary adviser to include any adviser that manages IRA or plan assets with discretion—in a sense, a one-part test, which is, does the adviser have discretion. To quote the regulation (§ 2510.3-21(c)(1)), a person is a fiduciary if:

Such person either directly or indirectly (e.g., through or together with any affiliate) –

(A) Has discretionary authority or control, whether or not pursuant to agreement, arrangement or understanding, with respect to purchasing or selling securities or other property for the plan;…”

To avoid confusion that could result from the use of the word “plan” in the quoted language, that term includes IRAs for purposes of the prohibited transaction rules. (See Code section 4975(e)(1).)

Going back to the example, if the fiduciary adviser had instead used a blended fee of, e.g., 85 basis points, the adviser could have discretion to reallocate the investments between equities and fixed income without running afoul of this prohibited transaction rule—because those changes did not and could not increase the adviser’s fees.

An alternative solution would be to change the allocation to nondiscretionary—that is, changes to the allocations could only be done only with client consent, and then to rely on, and comply with, Prohibited Transaction Exemption 2020-02. For firms that are already complying with that PTE (for example, to recommend rollovers), that is a workable approach that would allow the adviser to retain the different fee levels for fixed income and equities (and possibly for additional asset classes) while complying with the rules.

Both of these solutions require thought and documentation. As a result, they should only be implemented in consultation with an attorney who is knowledgeable about these issues and rules.

While this article focuses on allocations among asset classes where the adviser charges different fees, the prohibited transaction rules apply to any use of the income or assets for the benefit of a fiduciary adviser. That would include, for example, the inclusion of proprietary investments (e.g., mutual funds) in managed accounts. The issues for that type of arrangement are even more complex. For example, there is an exemption that permits the receipt the higher of the two fees (that is, the account fee or the fund fee), but that approach has not an attractive option in most cases. The use of a nondiscretionary approach under PTE 2020-02 offers opportunities to firms that are willing the comply with the conditions of the exemption.

At the beginning of the article, I also quoted subparagraph (F) of the Code’s prohibited transactions. It is a slightly different prohibition. For example, it could apply to payments from custodians and 12b-1 fees (or other payments) from mutual funds or their affiliates. But that is for another article in the future.

Conclusion

 It is clear that regulatory and enforcement attention is turning to rollover IRAs—witness PTE 2020-02. I think that the regulators’ attention will also extend to IRAs more generally. As a result, now is the time to review practices related to advice to IRAs and to ensure that the practices of investment advisers (and other investment professionals) are complying with ERISA and the Internal Revenue Code, and particularly with the prohibited transaction rules. This article will help identify some of the practices that could be problematic.

Share

A Rollover Recommendation Is a Securities Recommendation

Key Takeaways

    • The Department of Labor considers a rollover recommendation to be a recommendation to liquidate the investments in a participant’s 401(k) account or to transfer (and change) securities.
    • In addition, as explained in earlier articles, the DOL considers a plan-to-IRA rollover to be a change of account type, e.g., from a 401(k) account to an IRA account.
    • The SEC and FINRA are in alignment with the DOL’s position that a recommendation to roll over is, in effect, a securities recommendation, e.g., to liquidate the investments in the 401(k) account and rollover cash (since 401(k) plans almost never transfer the plan’s investments to an IRA and in some cases, it would not be legally permissible, e.g., collective investment trusts, CITs).
    • This may explain why the DOL, SEC and FINRA all expect broker-dealers and investment advisers to have information about the investments held in a participant’s account, that is, how can a “sell” recommendation be made without knowing the investments that the recommendation covers.

In the preamble to PTE 2020-02, the DOL explained its view that:

 A recommendation to roll assets out of a Title I Plan is necessarily a recommendation to liquidate or transfer the plan’s property interest in the affected assets and the participant’s associated property interest in plan investments.35 Typically the assets, fees, asset management structure, investment options, and investment service options all change with the decision to roll money out of a Title I Plan. Moreover, a distribution recommendation commonly involves either advice to change specific investments in the Title I Plan or to change fees and services directly affecting the return on those investments.

Continue reading A Rollover Recommendation Is a Securities Recommendation

Share

Most Popular Insights for the Third Quarter

Each calendar quarter, I post approximately 12 articles on my blog, fredreish.com. This quarterly digest provides links to the most popular posts during the past three months so that you can catch up on what you missed or re-read them.

  • Best Interest Standard of Care for Advisors #95: The Four Effective Dates for PTE 2020-02

    The DOL’s fiduciary interpretation and Prohibited Transaction Exemption (PTE) 2020-02 and its requirements were not all effective at the same time, causing some confusion. This article discusses the four effective dates or, more appropriately, enforcement dates.

  • Best Interest Standard of Care for Advisors #96: Annuity Recommendations, PTE 84-24, and Fiduciary Misunderstandings

    The DOL’s expanded interpretation of fiduciary advice as described in the preamble to Prohibited Transaction Exemption (PTE) 2020-02 applies to all rollover recommendations, including recommendations to roll over into annuities. A fiduciary recommendation to roll over from an ERISA-governed retirement plan results in a conflict of interest that is a prohibited transaction under the Internal Revenue Code and ERISA. This article discussed the DOL’s expanded interpretation in the context of the insurance industry, relief provided by PTE 2020-02 and PTE 84-24, and the conditions that must be satisfied for each.

  • Best Interest Standard of Care for Advisors #97: The SEC Requirements for Rollover Recommendations

    When conflicted fiduciary advice is given to retirement investors — that is, retirement plans, participants (including rollovers), and IRA owners — it results in prohibited transactions under the Internal Revenue Code and ERISA. However, PTE 2020-02 provides relief for conflicted non-discretionary recommendations. While most of the focus of the literature, and of these blog articles, about rollover recommendations has been on the DOL’s fiduciary interpretation and PTE 2020-02, the SEC has, for the most part, harmonized its best interest/fiduciary requirements for rollover recommendations with those of the DOL. This article discusses the two-part harmony between the agencies, and the areas of disharmony.

Share

Investment Advisers: The Independent Duties of Care and Loyalty

Key Takeaways

  • Recent SEC guidance has clarified that the investment adviser duties of care and loyalty are separate, independent duties.
  • A reasonable interpretation of the SEC and Staff guidance is that the satisfaction of one will not satisfy the other–both must be individually satisfied.
  • As a result, the SEC appears to be saying that, even if a conflict is disclosed, that does not, in and of itself, satisfy the duty of care. For example, if an adviser discloses that the adviser will receive compensation related to an investment decision or recommendation, e.g., revenue sharing, but the revenue sharing share class of a mutual fund is more expensive for the investor, the duty of care may be violated even though the duty of loyalty was satisfied.

There appear to be conflicting views of whether an investment adviser’s duty of care can be satisfied by disclosures that satisfy the duty of loyalty. That is, if an adviser discloses the receipt of additional compensation from investments or service providers, can the adviser then recommend or select that investment even though it may be more expensive for the client?  In recent years, the SEC has issued guidance that seems to answer that question…and the answer appears to be “no.” Based on its 2019 Commission Interpretation Regarding Standard of Conduct for Investment Advisers, and the two 2022 SEC Staff Bulletins, the position of the SEC (and of the Staff) is that the duties of care and loyalty (together referred to as the duty to act in the best interest of investors) are separate and distinct, and that they each must be independently satisfied.

Continue reading Investment Advisers: The Independent Duties of Care and Loyalty

Share

Best Interest Standard of Care for Advisors #100: Liabilities and Opportunities

Key Takeaways

The DOL’s expanded definition of fiduciary advice is explained in the preamble to PTE 2020-02.

When conflicted fiduciary advice is given to retirement investors, that is, retirement plans, participants (including rollovers), and IRA owners (including transfers of IRAs), it results in prohibited transactions under the Internal Revenue Code and ERISA. The prohibited transaction is the compensation earned as a result of the fiduciary recommendation, e.g., the fees or commissions from a rollover IRA.

The PTE provides relief for the prohibitions resulting from conflicted non-discretionary recommendations. However, the relief is conditional, that is, it is only available if all of the PTE’s conditions are satisfied.

The compliance deadline was February 1, 2021 for most of the PTE’s conditions and July 1 for the one remaining condition–the requirement to provide retirement investors in writing with the “specific reasons” why a rollover recommendation is in their best interest.

As a result, the documentation and processes for compliance with PTE 2020-02’s conditions should now be completed. So, this is a good time to consider the liability issues and the opportunities created by the PTE.

Background

The DOL’s prohibited transaction exemption (PTE) 2020-02,  Improving Investment Advice for Workers & Retirees, allows investment advisers, broker-dealers, banks, and insurance companies (“financial institu­tions”), and their representatives (“investment professionals”) to receive conflicted compensation resulting from non-discretionary fiduciary investment advice to ERISA retirement plans, participants (including rollover recommendations), and IRA owners (all of whom are referred to as “retirement investors”). In addition, in the preamble to the PTE the DOL announced an expanded definition of fiduciary advice, meaning that many more financial institutions and investment professionals are fiduciaries for their recommendations to retirement investors and, therefore, will need the protection provided by the exemption.

Since a significantly increased number of recommendations to retirement investors will be fiduciary recommendations under the expanded fiduciary interpretation, and since many, if not most, of those recommendations will involve conflicts of interest, financial institutions and investment professionals will need to satisfy the “conditions” (or requirements) in the PTE. The 4 categories of those conditions are: (1) the Impartial Conduct Standards (including the best interest standard of care); (2) disclosures (including the “specific reasons”), (3) policies and procedures (include mitigation of conflicts), and (4) the annual retrospective review and report.

Continue reading Best Interest Standard of Care for Advisors #100: Liabilities and Opportunities

Share