ESOPs & Employee Benefits Q2 2023 Client Update
We hope your summer is off to a great start! Please see below for our thoughts on recent developments in the employee benefits field. As always, we are happy to discuss these or other issues in more detail.
SECURE 2.0 Updates: Some Clarity, Still Confusion
Although enacted at the end of 2022, the SECURE 2.0 legislation aimed at retirement plans continues to generate confusion. But we have also seen some small measures of clarity.
The SECURE 2.0 provision mandating that certain highly paid employees only make Roth (and not pre-tax) catch-up contributions tops most lists of unanswered questions. This provision does not take effect until 2024, but in the meantime many plan sponsors and vendors are struggling to understand and accommodate some of the finer points of this requirement. For example:
- The new rule applies only to participants who earn over $145,000 in the prior year, which is a different threshold than the routinely used “highly compensated employee” threshold, so plan sponsors will need to track this participant group on its own.
- The $145,000 limit uses a specific definition of compensation that is not necessarily used for all plan purposes, so not only will the participant population need to be tracked separately, but a separate calculation of plan compensation may also be required.
- It is not clear whether plans may require that all catch-up contributions be made on a Roth (and not pre-tax) basis; in other words, can plans eliminate pre-tax catch-up contributions entirely?
- It is also unclear how this rule will impact participants who make pre-tax deferral elections, but whose deferrals continue after reaching the catch-up threshold without making a separate election (or without consenting to) making Roth contributions.
The new rule allowing employees to choose to receive employer contributions on an after-tax Roth basis—which, unlike the mandatory catch-up provision above, is permissive, so plans can choose not to allow it—has presented a similar set of questions. Hopefully we will have a clearer picture on many of these unresolved questions soon.
Relatedly, following a technical glitch in the SECURE 2.0 legislation that arguably eliminated the ability to make catch-up contributions at all, Congressional leaders released a letter declaring their intent to introduce technical revisions to the law and confirming they did not intend this outcome.
In the same letter, they clarified a paradox in the new required minimum distribution (RMD) ages introduced in SECURE 2.0. As written, the legislation mandated two different RMD starting ages for individuals born during 1959. The letter clarified the intended RMD age for this group.
Finally, the IRS has offered some preliminary guidance on the newly expanded self-correction rules for retirement plans. While a number of items remain open, the expanded self-correction opportunities should result in fewer time-consuming and expensive voluntary correction submissions to the IRS.
Given that these are just four of the nearly 100 benefits changes in the law, we expect further guidance to be released later this year (and in later years) addressing these items and many others. As we approach the end of 2023, employers will need to consider which optional provisions to allow and how they and their vendors will begin to implement the mandatory provisions.
DOL to Move Forward on ESOP Adequate Consideration Rules
In early April, the Department of Labor (the “DOL”) committed to move forward with a public notice‑and‑comment rulemaking on regulations to define “adequate consideration” under Section 408(e) of ERISA. These are key regulations the ESOP community has sought clarity on since 1974, as they govern the valuation method on which ESOP transactions are based. The DOL has shown reluctance to issue final rules over the years, and in the meantime, has instead increased its oversight of ESOP formations largely through litigation. This enforcement approach has resulted in an uncertain regulatory landscape, particularly for the last decade.
The ESOP Association had previously petitioned the DOL to move forward on the “adequate consideration” regulations under the federal Administrative Procedure Act, and SECURE 2.0 mandated that the DOL do so.
As a first step, the DOL will publish draft proposed regulations through public notice and opportunity for comment from stakeholders. The DOL stated that specific timing of next steps will depend on the amount of public engagement sessions with interested stakeholders, so the final regulations may not be issued for a year or two, or potentially longer, but in any case, they will have a lasting impact on the formation and operation of ESOPs moving forward.
Employee Ownership Remains a Viable Alternative in Economic Uncertainty, Especially Now
As the economy remains on somewhat uncertain footing, slowing many traditional forms of corporate transactions, employee ownership remains an important alternative for business owners considering succession planning. Be on the lookout in the coming weeks as we dig deeper into how this transition can unfold, what makes employee ownership transitions ideal during times of economic uncertainty, what the federal government is doing to make ESOP lending more accessible, and how traditional ESOPs compare to a little-used technique called an “employee ownership trust.”
In the meantime, we hope you enjoy the rest of your summer and welcome you to reach out to any of our ESOPs & Employee Benefits lawyers to discuss any of these topics further.
The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2023.