The SECURE Act 2.0: The Most Impactful Provisions #13 — Starter 401(k) Plans and Safe Harbor 403(b) Plans

Key Takeaways

  • Most employees who work for large and mid-sized employers have the opportunity to defer money from their paychecks into a savings-based retirement plan. That is not the case with many small employers, though, where large numbers of employees work for firms that do not offer plans.
  • However, savings-based plans are critical for employees to obtain financial security in retirement. There are studies that show that employees who can defer into retirement plans will save much more for retirement that those who do not have access to plans.
  • Based on surveys, small employers do not offer plans because they are worried about the cost and administrative complexity of setting up and operating plans.
  • To allay that concern, Congress created, in SECURE 2.0, a new type of plan that is simple and low cost: “Starter” 401(k)s and “Safe Harbor” 403(b)s. The purpose of this new plan design is to encourage small employers to set up plans that enable their workers to save for retirement through deductions from their paychecks.

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 SECURE Act 2.0 and previous retirement plan laws is that many of 2.0’s provisions are optional…that is, plan sponsors are not required to adopt the provisions, but can adopt them if they decide that the change will help their plans and participants. This series discusses the provisions that are likely to be the most impactful, either as options or as required changes.

This article is about an effort by Congress to extend plan coverage for workers at smaller employers by creating a new and straightforward type of low-cost plan:  the Starter 401(k) and Safe Harbor 403(b).

The Senate Finance Committee’s summary of the provision is:

Section 121 [ of the Act], Starter 401(k) plans for employers with no retirement plan. Section 121 permits an employer that does not sponsor a retirement plan to offer a starter 401(k) plan (or safe harbor 403(b) plan). A starter 401(k) plan (or safe harbor 403(b) plan) would generally require that all employees be default enrolled in the plan at a 3 to 15 percent of compensation deferral rate. The limit on annual deferrals would be the same as the IRA contribution limit, which for 2022 is $6,000 with an additional $1,000 in catch-up contributions beginning at age 50. Section 121 is effective for plan years beginning after December 31, 2023.

This new plan design allows only for employee deferrals. Employer contributions are not permitted. If employers want to make contributions for their employees, they need to set up a “regular” plan or join a PEP or MEP.

Also, the deferral limits are low…basically they deferral limits are the same as the contribution limits for IRAs. However, this arrangement could be better than contributing to IRAs for employees (for example, under one of the state-mandated, IRA-based plans) because (1) the combined assets in the plan will be more than the assets in individual IRAs which will likely enable the plan to obtain lower cost investments than individual IRAs could, (2) the combined assets may support more services for participants than individual IRAs could, and (3) if the employer later becomes more successful in the future and wants to begin making contributions to a plan, the Starter 401(k) can be converted into a “regular” plan (e.g., a safe harbor 401(k) or a traditional 401(k)). This last point compares favorably with IRA-based programs, which cannot be converted into 401(k) plans. (It is possible that IRA money could be rolled over into a 401(k) plan, but that is a decision that has to be made by each IRA owner, not by a plan sponsor.

Because of these advantages compared to IRA-based plans, Starter 401(k)s have the potential to be formidable competitors to mandated state IRA-based programs.

Beyond that, it is likely that the providers of Starter 401(k) plans and Safe Harbor 403(b) plans will understand that small employers are thinly staffed and, as a result, they will provide the administrative support to take on  as much of the administrative burden as possible.

Concluding Thoughts

This new plan design is one more step in the ongoing efforts by Congress to make savings-based retirement plans attractive to small employers. That is because the real gap in plan coverage is with small employers. While the private sector has been working on expanding plan coverage for decades, there are still significant gaps in the coverage. As a result, many American workers cannot save for retirement through the proven and successful process of payroll withholding. That is not acceptable from a public policy perspective.

In a sense, this new plan design is a test of the private sector service and advice providers. If this doesn’t work, the next step may be mandated retirement plans for small employers. In that case, the mandate could be a booming industry for PEPs, MEPs and GoPs. (For the uninitiated, those are the acronyms for pooled employer plans, multiple employer plans, and groups of plans.)

With regard to mandates, we are now seeing interesting data that, where states mandate IRA-based retirement programs, there is an increase in the adoption of private sector retirement plans. The rationale may be that, if an employer has no choice but to allow employee deferrals to IRAs, at least some employers would prefer to sponsor retirement plans that can provide better coverage for the higher compensated employees and perhaps better benefits for the employees generally.

The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Faegre Drinker.