Overview
As you may know, the SECURE 2.0 Act expanded or enhanced many of the rules applicable to retirement plans. Included in the Act are provisions promoting the creation of new employer-sponsored retirement plans by small employers, tax credits, and the potential for eligible employees to make contributions on a Roth basis to a new or existing simplified employee pension (SEP) or Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) individual retirement account (IRA) plan. Recently, the Internal Revenue Service (IRS) issued Notice 2024-2 providing clarification to these expanded rules. This article will primarily focus on the effects Notice 2024-2 has on SEP and SIMPLE IRA plans.
Tax credit for small employers
Small employer plan startup cost tax credits have been in place for some time. Basically, an eligible small employer can receive a tax credit to offset a SEP or SIMPLE IRA plan’s startup costs during a new plan’s initial three-year period. Generally, small employers are defined as employers with 100 or fewer employees that earned $5,000 or more in the preceding year.
The SECURE 2.0 Act expanded the existing tax credit for small employers with 50 or fewer eligible employees. This means a higher percentage of plan startup costs would be eligible for the tax credit. Small employers with 51-100 eligible employees would continue to have the original plan startup cost tax credit. The Act created a new tax credit available to small employers during the initial five years of a new plan that is based on employer contributions under the plan. The new tax credit can be taken for employer matching or nonelective contributions (i.e., not salary deferrals) up to $1,000 for each eligible employee. This tax credit is phased out over five years on a percentage basis of the $1,000 or actual contribution amount.
Notice 2024-2 explains the enhanced startup cost credit and new employer contribution credit are only available for tax years beginning after 2022. However, if a plan was effective before 2023, an employer can still take advantage of the remaining years of the three- or five-year initial plan period. The Notice also explained that the new tax credit for employer contributions during the five-year period begins with the year the plan is effective and that both credits may be available for the same years. In the case of questions relating to these tax credits, employers should be directed to their tax professionals for guidance.
SIMPLE Plan contribution increases
Another SECURE 2.0 Act provision clarified by Notice 2024-2 is specific to SIMPLE IRA plans for plan years beginning after 2023. The Notice clarifies that the rules now allow for either an automatic increase or an allowable increase in SIMPLE IRA plan contributions. For eligible employers with 25 or fewer eligible employees, the specified elective deferral limit, and the employee catch-up contribution limit available to employees aged 50 or older, are automatically increased by 10 percent.
For example, the employee SIMPLE IRA elective deferral limit for 2024 is $16,000, however, with application of this provision the limit becomes $17,600 and the catch-up deferral of $3,500 becomes $3,850 for eligible employers with 25 or fewer eligible employees.
For a small employer with more than 25 eligible employees, however, the increased limits only apply if the employer makes an election to apply the increased elective deferral limits and makes an additional employer contribution. The additional contribution would either be a match on deferrals up to 4 percent of compensation (versus the standard 3 percent) or a nonelective contribution of 3 percent (versus the standard 2 percent).
The Notice clarifies that employers are eligible employers if, during the three-taxable year period prior to establishing the SIMPLE IRA plan, the employer did not maintain an IRC section 401(a), 403(a), or 403(b) plan providing contributions or benefits that covered the substantially same employees for the employer. Additionally, the Notice states that eligible employers with more than 25 eligible employees must take formal action to make an election to increase limits and maintain documentation. Any eligible employer must also notify participants of the increased contributions and limits and amend its plan by the required deadline. This notice must be included with the required annual employer notification and, for this reason, unless the employer provided this notification prior to November 2, 2023, the employer would not be able to implement this provision to an existing SIMPLE IRA plan until the 2025 plan year.
Finally, the Notice includes a comment specifying that employers are allowed to make an additional nonelective contribution for years beginning after 2023. This additional contribution can be up to 10 percent of compensation but not more than $5,000 per employee.
SIMPLE Plan mid-year termination
Another provision, also specific to SIMPLE IRA plans for plan years beginning after 2023, clarified by Notice 2024-2 provides that an employer with a SIMPLE IRA plan may terminate the plan mid-year if the employer replaces it with a safe harbor 401(k) plan for the remainder of the year. There are various requirements that must be coordinated in this process that the Notice points out. One item is the requirement to contribute all salary deferrals for compensation paid and required match or nonelective contributions owed through the termination date. A second item requires an employer to notify employees of the plan’s termination at least 30 days prior to the termination date. Additionally, the Notice states the employer should notify the SIMPLE IRA’s custodian or trustee and its payroll provider of the salary deferral cessation, as well as to keep all records regarding the SIMPLE IRA plan termination. A third item allows SIMPLE IRA owners to rollover their terminated SIMPLE IRA assets to a 401(k) or 403(b) plan prior to satisfying their SIMPLE IRA two-year holding period. A fourth item relates to the salary deferral limit in the termination/replacement year. Since the annual deferral limits are different under SIMPLE IRA and 401(k) plans, the total amount of the limit that year is a weighted average of days participating in both plans times the applicable limits under each plan for the year. A fifth item in the Notice is the requirement, applicable to the safe harbor 401(k), to provide a notice accurately describing the type and amount of compensation that may be deferred and the limits on contributions for that year.
SEP and SIMPLE IRA Plan Roth contributions
A provision included in the SECURE Act 2.0 allows employers to offer SEP and SIMPLE IRA plan participants the ability to elect contributions under the respective plan be made to a Roth SEP IRA or a Roth SIMPLE IRA. This provision, effective in 2022, was also clarified by Notice 2024. Please note, employers sponsoring SEP or SIMPLE IRA plans are not required to allow employees to designate contributions under its plan to a Roth IRA.
SEP plans usually only provide for nonelective contributions from the employer. Salary reduction SEPs (SARSEPs) are an exception. SIMPLE IRA plans allow employee elective deferrals and require an employer made nonelective or matching contribution. Employers sponsoring such plans may now choose to allow no contribution types, all contribution types, or specific contribution types to be made on a Roth basis according to the employee’s designation.
The Notice clarifies several questions about these contributions including:
- First, all participants must have the same effective opportunity to make a Roth contribution election and this affirmative election must be made before the contribution.
- Second, the Notice reiterates that any SEP or SIMPLE contribution made to a Roth IRA on the participant’s behalf is ‘not’ excludable from the participant’s gross income. The year in which an employer match or nonelective contribution to the Roth SEP or SIMPLE IRA is included in income is the tax year in which that match or nonelective contribution is deposited. For elective deferrals it is the year the participant would have otherwise received the amount as wages or salary.
- Third, employer reporting of income on these contributions to participants is different depending on whether the Roth contribution is due to elective deferrals or matching or nonelective contributions. The Notice states that elective deferral contribution amounts to a Roth SEP or Roth SIMPLE IRA are reported on a Form W-2 in Box 12 using code S (for SIMPLE) or code F (for SARSEP) and are included in the amounts shown in Boxes 1, 3, and 5. Furthermore, because employer matching and nonelective contribution amounts are not meant to be tax-free gifts, the amounts must be included in the employee’s income and for this reason are reported on an IRS Form 1099-R for the year in which the contribution is made to the employee’s Roth SEP or Roth SIMPLE IRA. So like an IRA custodian or trustee reports a distribution from a traditional or SIMPLE IRA that is converted to a Roth IRA, an employer reports matching or nonelective contributions made to an employee’s Roth SEP or Roth SIMPLE IRA in Boxes 1 and 2a of Form 1099-R using code 2 (i.e., participant is younger than age 59½) or code 7 (i.e., participant is age 59½ or older) in Box 7. Additionally, the employer is instructed to check the IRA/SEP/SIMPLE checkbox in Box 7.
- Fourth, the Notice indicates elective deferrals of salary or wages are subject to income tax withholding, FICA, and FUTA taxes whereas employer matching and nonelective contributions are not. An important point made in the Notice is that since employer matching and nonelective contributions are not subject to withholding but are taxable, employees should take steps to increase withholding or make estimated tax payments to account for this extra income. Finally, the Notice indicates that employers can continue to use their existing IRS Model or prototype SEP and SIMPLE plans, unamended, for provisions allowed and described above until the IRS releases new Model forms or issues new guidance for prototypes. Unfortunately, the Notice does not include any guidance as it relates to administration or reporting by Roth IRA custodians or trustees.
Extended deadline to implement changes
Finally, the Notice provides an extended deadline for incorporating changes in law or regulations into IRA agreements or IRA-based employer plans relating to required or allowable provisions of the SECURE 2.0 Act, the SECURE Act, the CARES Act, and the Taxpayer Certainty and Disaster Tax Relief Act of 2020. This deadline was extended to December 31, 2026, or such later date as the Secretary of the Treasury prescribes in guidance.
Summary
There are many changes attributed to the SECURE 2.0 Act and IRS Notice 2024-2 addressed a handful of them. We have highlighted a subset of these, those applicable to IRA based employer SEP and SIMPLE IRA plans. An employer incorporating any of the SEP or SIMPLE IRA plan provisions of the SECURE 2.0 Act, as well as the IRS Notice 2024-2 issues described above, should discuss these with their legal counsel and tax professionals prior to their implementation.
Additional guidance, including regulations, is expected, and we will keep you informed.
