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How the SECURE Act and CARES Act Affect 401(k)s for SMBs

Gusto Editors  
CARES Act 401(k)

Wondering how the SECURE Act and the CARES Act affect your 401(k) plan? Still deciding whether it’s worth investing in a 401(k) plan for your business? 

Here at Gusto, we want our customers to have all the available information and support they need to thrive as business owners and financial advisors. That’s why we’re thrilled to bring you expert knowledge about how the SECURE Act and CARES Act affect 401(k)s for SMBs. 

A recent webinar “401(k)s and Why Small Businesses Should Start a 401(k)” provided education for accountants — equipping them with a well-rounded understanding of retirement investments and the pros and cons of advising clients on offering a 401(k).  

The host for this event was Nicolle Willson, Head of Retirement Consulting at Guideline. She walked through the ins and outs of 401(k)s, how they benefit small businesses, how the SECURE Act and CARES Act is impacting retirement investments, and all about non-discrimination testing.

This sessions covered several features related to 401(k)s and small businesses, which were broken down into three different parts. In Part One, they cover 401(k) basics and why small businesses should start one. In Part Two, which this article covers, they dive into how the SECURE Act and CARES Act Affect 401(k)s for SMBs. And finally, Part Three discusses Non-Discrimination Testing for 401(k) Plans and the Safe Habor Plan

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What is the SECURE Act? 

Let’s talk about the SECURE Act first.

SECURE stands for ‘Setting Every Community Up for Retirement Enhancement.’ According to Congress, this act is intended to improve upon the success of the employer-based retirement system, and that includes 401(k) plans. The act seeks to make it easier for businesses to offer retirement plans and for individuals to save for retirement.

Nicolle Wilson  

Most of the provisions of the SECURE Act are effective for tax years after December 31, 2019. The SECURE Act brought about several changes to retirement plans which can be confusing to navigate, but Nicolle did an incredible job summarizing them for us. 

The SECURE Act and how it affects 401(k) tax credit

#1: Retirement plan startup cost credit 

According to previous regulations, employers are eligible to receive this credit if they have 100 or fewer employees who made at least $5,000 from the preceding year AND at least one NHCE — “non-highly compensated employee” as a plan participant. In Part Three of this webinar, Nicolle explains an NHCE in more detail, but for now, you can think of an NHCE as a typical break-and-file employee. 

The credit was capped at $500 for each year for three years max and could only be used to fund 401(k) startup costs. 

With the new changes brought by the SECURE Act, more credit has been provided!

Now it’s been increased to the greater of $500, or it’s going to be the lesser of $250 for each NHCE, or $5,000. So the credit is still going to apply for up to three years, and it is still limited to 50% of eligible startup costs. These include ordinary and necessary costs to set up and administer the plan and educate employees about the plan. Basically here what the SECURE Act has changed is previously you could get $1,500 max in tax credits over three years for starting a 401(k) plan. That maximum has now increased to $15,000, and this could be a huge deal to some businesses.

Nicolle Wilson 

As Nicolle said, this could be huge for small to mid-sized businesses that want to start offering their employees 401(k) benefits. But the good news doesn’t stop there — the SECURE Act has several more provisions to offer.

#2: Small plan auto-enrollment credit 

Small plan auto-enrollment credit is given to small businesses that add a new eligible automatic contribution arrangement (EACA) to a 401(k) plan, beginning on or after January 1, 2020. 

In order to qualify for this credit, you have to qualify for the startup credit as well, and if your business retirement plan already had auto-enrollment in 2019, you would not be eligible for this credit. 

Three manufacturing employees standing with the backs to us wearing hard hats

Here’s what the credit entails: 

This credit is going to be a flat $500 credit per year for up to three years. The great thing about this credit is that it isn’t limited to plan expenses, which means it can be layered on top of the start-up credit. This is going to give small businesses the opportunity to get an additional $1,500 in total tax credits. Combined with a start-up credit, this is a potential $16,500 that can be saved over three years.

Nicolle Wilson 

This is great news for businesses looking to start a 401(k) plan for their employees. If you want help calculating the amount of tax benefits you could receive, Nicolle has a handy Guideline calculator for you! By visiting their website and entering some basic company information, Guideline will show you the net cost of starting a retirement plan for your particular business.

We have found that the net cost to businesses with less than five employees can basically be $0 for the first three years with these tax credits, which is pretty amazing in this day and age.

Nicolle Wilson

Staring a 401(k) plan for your SMB may not be too difficult and pricey after all!

The SECURE Act and other provisions for your 401(k) 

The SECURE Act primarily brought about tax credit updates, but there are some other changes that you need to be aware of to inform your decision on whether or not to start a 401(k) plan for your small business. 

#1: Long-time part-time employees (LTPTs)  

Previously, employers were allowed to exclude certain part-time employees from receiving a 401(k) plan in order to keep administrative costs down for their businesses. In other words, business could require employees to at least work 1,000 hours in a year to participate in their 401(k) plan. 

However, the SECURE Act changed this rule, requiring employers to allow long-term part-time employees to participate in their 401(k) plan. 

What qualifies an employee to be long-term part-time? 

LTPTs [are] anyone who worked at least 500 hours a year for three consecutive years. It’s basically anyone who works at least 10 hours a week on a regular basis, or alternatively, it could be seasonal employees who come back every year.

Nicolle Wilson

This new regulation may cause some initial anxiety for SMB owners. After all, won’t adding LTPTs to their 401(k) increase administrative costs? Not exactly…

In this modern era 401(k), there’s still going to be a lot of low cost options out there for them, and it is really important in the grand scheme of things that even part-time workers get to save for their retirement. All in all, I think this is a good step in the right direction, especially with the low cost that you can find right now.

Nicolle Wilson  

Nicolle’s right — by allowing your LTPT employees into your business 401(k) plan, you’ll do them a great service. And with all the tax provisions offered by the SECURE Act, 401(k) administrative costs will be relatively low. 

#2: Late plan adoption 

Previously, business owners had until December 31 of any given year to institute a calendar year 401(k) plan. According to new legislation from the SECURE Act, this deadline has been changed to the employer’s tax filing deadline, plus extensions for that year. 

[It’s] basically very similar to the SEP IRA. This deadline is limited to employer contributions — so profit sharing only. That just basically means employees can’t contribute anything from income paid to them before the plan start date. But this is a good opportunity for people like sole practitioners who might have delayed starting a 401(k) plan for themselves to basically get in some extra tax deductions before their tax filing deadline.

Nicolle Wilson  

Employers will still need to ensure that their 401(k) plan is filed in a timely manner; however, the SECURE Act offers late plan adoption, which is an attractive option to many SMBs. 

Male and female colleagues in bakery using a tablet to record something

#3: Multiple employer plans (MEPs) and pooled employer plans (PEPs) 

To join an MEP, employers must be related — i.e. they’re under the same payroll provider or linked through trade association. In PEPs, employers are only related by belonging to the same 401(k). Previously, PEPs were not considered “officially legitimate,” but the SECURE Act has authorized these plans as long as they meet certain requirements. 

One condition is that they must designate a pooled plan provider to oversee an administrative plan. However, each employer is going to retain fiduciary responsibility for monitoring the PPP, as well as other plan fiduciaries. The employer is also going to be responsible for investment management, unless they delegate out to what’s called a 3(38) investment manager who will then take over fiduciary responsibility for investments by contract.

Nicolle Wilson 

In addition to authorizing PEPs, the SECURE Act is softening the “bad apple rule” — stating that if one employer in the 401(k) plan failed to keep their part of the plan compliant, the entire plan would be disqualified. 

Now, as long as the PPP recognizes the bad apple and spins off their assets in a timely manner, that plan will maintain its qualified status.

Nicolle Wilson

This is great news for small business owners — MEPs and PEPs are especially attractive to SMBs because of their low cost and ease in administration. However, there are also several low-cost individual plan options as well, so make sure to shop around before deciding to join a MEP or PEP. 

#4: Required minimum distributions

Previously, you had to be 70-and-a-half years old to take required minimum distributions (RMDs) from all non-Roth IRAs and 401(k) plans if you were no longer working. However, with the SECURE Act, that date has been extended to the date you turn 72.

The first RMD must be taken by April 1st of the year following that date and then on December 31st thereafter. This provision is going to be effective for everyone born after June 30th, 1949 — basically anyone who didn’t turn 70-and-a-half on or before December 31st, 2019. Important to note — it hasn’t changed that if you are not a greater than 5% owner of the business and you continue to work after that date has passed, you don’t actually have to start taking RMDs until you stop working.

Nicolle Wilson 

For older business owners who need to continue saving, this date extension is great news. In addition to extending this date, the SECURE Act has also made some changes to stretch IRAs and RMDs.

It used to be that beneficiaries of retirement accounts could set up what is called a stretch IRA. Basically, you have the IRA account stretch payments over the beneficiary’s lifetime so that the annual tax assessment wasn’t super bad. The SECURE Act is now going to eliminate stretch payments for most beneficiaries, so you must deplete that account over the span of a maximum 10 years now.

Nicolle Wilson

Here are a few expectations to this rule that Nicolle mentioned:

  • If you are a spouse, you can still roll funds into your own retirement account and follow your own RMD schedule.
  • If you are no more than 10 years younger than the decedent, you can still roll funds into your own retirement account and follow your own RMD schedule.
  • If you are a minor child or disabled, you can still roll funds into your own retirement account and follow your own RMD schedule.

#5: Withdrawals for birth and adoption 

According to the SECURE Act, withdrawals for a birth and adoption are new distributable events for 401(k) plans. You can take a withdrawal up to $5,000 from your 401(k) for a qualified birth or adoption. 

There is no 10% premature distribution penalty for this withdrawal, and you can even have the option to repay the funds back to the plan or to an IRA if you wish.

Nicolle Wilson 

Welcoming a new baby into your home is a joyous moment, but we all know that it can also be expensive. Thankfully, you can pull funds from your retirement account if needed to fund this new adventure.

#6: Disaster relief withdrawals 

Finally, let’s talk about disaster relief. The SECURE Act has expanded on federal disaster for major disasters between January 1, 2018 and February 18, 2020 — including hurricanes Florence and Michael as well as the California wildfires.

There is a $100,000 maximum distribution and no 10% penalty for premature withdrawals. The funds can also be repaid to the plan under certain circumstances and taxes can be spread out over three years.

Nicolle Wilson 

This new provision takes some pressure off individuals when deciding whether to save for retirement or have an emergency fund to prepare for disasters. Now, they can do both.

What is the CARES Act? 

Now that we’ve covered the changes the SECURE Act brought to 401(k) benefits and provisions, it’s time to move on to what the CARES Act has provided for SMBs. 

The CARES Act is the Coronavirus Aid, Relief, and Economic Security Act that was passed by Congress in March 2020 in response to the economic downturn caused by the pandemic. This act gave over $2 trillion in economic relief to workers and small businesses in order to preserve and protect American jobs from COVID-19.  If you want to learn more about the CARES act, check out this article

In the webinar, Nicolle discussed two specific provisions of the CARES Act that affect 401(k) plans that we want to share with you.

The CARES Act and how it affects SMBs’ 401(k)s

#1: Coronavirus 401(k) distributions 

The CARES Act created a new distributable event which allows qualified individuals to withdraw up to $100,000 from their 401(k) account.

This was a pretty huge deal in the 401(k) world because this is pretty much the ultimate way to get much needed emergency money out of your 401(k) without having a significant penalty.

Nicolle Wilson 

As Nicolle said, this is great news! But how do you know if you’re qualified? Here are the requirements to receive this COVID-19 relief withdrawal from your 401(k). 

  • You have been diagnosed with COVID-19, or…
  • Your spouse or dependent has been diagnosed with COVID-19, or… 
  • You have experienced adverse financial consequences due to the pandemic. You’re financially struggling as a direct result of a required quarantine, being laid-off, having work hours reduced, being unable to work because of lack of childcare, having to close your business, or having to reduce your business hours because of COVID-19.

If you qualify for this distribution, you must take it sometime in 2020. If you’re under 59 and a half, … you will not have to pay a 10% penalty. You can also spread the regular tax liability over a three-year period, and you can repay the amount back to the plan on [the] IRA as long as it’s within three years. So this is a great alternative to taking a regular hardship distribution that generally comes with a 10% penalty and no repayment feature. It’s also a great alternative to a loan because you can pay back the funds and you don’t have to pay any interest back to your account.

Nicolle Wilson 

COVID-19 has wreaked havoc on global health and the economy — if you find yourself or your business in a position where you need additional aid, these COVID-19 distributions allowed from your 401(k) account may be the right way to go.

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#2: Added COVID-19 relief provisions for your 401(k) plan 

Now, let’s cover a couple more provisions that the CARES Act offers for your 401(k) plan if you meet the requirements for COVID-19 401(k) withdrawals. 

  • As long as you take out the loan before September 23, 2020, the loan has doubled from the lesser of $50,000 (50% of your vested benefit) to the lesser of $100,000 (100% of your vested benefit). 
  • The loan repayments that are due between March 27, 2020 and December 31, 2020 will be delayed by one year. 

Essentially qualified individuals now have the opportunity to take their entire 401(k) balance out as a loan, not make any payments for almost a year, and then pay it back slowly thereafter.

Nicolle Willson 

If you’ve been adversely affected by the pandemic, your 401(k) can act as an “emergency fund” in case you need it. However, Nicolle noted that withdrawing from your retirement account is a last-resort option. Your 401(k) is meant to save money over a long period of time and take advantage of compound interest, and if you have $0 in your account, you won’t be able to do that. These withdrawals are for emergencies only. 

Learn more about 401(k)s and why a small business should start one

There are a number of ways 401(k)s add value to small businesses and are easier than ever to set up. Plus, with the SECURE Act and CARES Act, tax benefits and other provisions are allowed, which can make your 401(k) plan more affordable and advantageous than ever. If you’re ready to start a 401(k) for your small business, Gusto and Guideline can help. We’ve partnered together to offer a fully integrated 401(k) system.

And if you’re an accountant, we hope that this webinar provided valuable information that helps you advise your clients.

If you want to learn more about 401(k)s and how they benefit small businesses, make sure to check out the full webinar here. Additionally, make sure to check out Part One of the webinar, “Basics and Why Small Businesses Should Start with a 401(k),” and Part Three, “Non-Discrimination Testing for 401(k) Plans and the Safe Habor Plan,” for valuable information regarding 401(k)s and how COVID-19 relief legislation will impact retirement investments.

Updated: August 17, 2021

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