Editor: Mo Bell-Jacobs, J.D.
The SECURE 2.0 Act of 2022, enacted Dec. 29, 2022, as Division T of the Consolidated Appropriations Act, 2023, P.L. 117-328, creates a new “pension-linked emergency savings account” (PLESA). If adopted by a plan sponsor, a PLESA would allow non–highly compensated employees in Sec. 401(k), 403(b), or governmental 457(b) plans to make after-tax Roth contributions to a separate PLESA account and to draw on that account as frequently as monthly to pay unpredictable, short-term emergency expenses, such as an auto repair.
The PLESA rules are found in Sections 801–804 of the Employee Retirement Income Security Act of 1974 (ERISA), with corresponding provisions in Sec. 402A(e) of the Internal Revenue Code, both as amended by Section 127 of the SECURE 2.0 Act, and are effective for plan years beginning after 2023.
PLESAs are intended to allow low- and middle-income employees to accumulate by payroll deduction easy-to-access funds that they can use in an emergency. Only non–highly compensated employees as defined in Sec. 414(q) may contribute to a PLESA (Sec. 402A(e)(2)). Highly compensated employees include employees with eligible compensation for the lookback year of more than $150,000 in 2023 (indexed for inflation). Such contributions must take the form of designated after-tax Roth contributions under Sec. 402A(e)(1)(A).
If an employee later becomes a highly compensated employee, the employee may not make further contributions to the account but retains the right to withdraw any account balance under the general terms of the plan (ERISA §801(b)(2)).
A contribution cannot be credited to the PLESA account if it would cause the balance attributable to employee contributions to exceed the lesser of $2,500 (as indexed for inflation after 2024) or other amount designated by the plan sponsor under Sec. 402A(e)(3). If any contributions cause a PLESA balance to exceed the maximum allowed amount, the participant may elect or will be deemed to have increased the contribution rate to another account in the plan so that the excess is credited to that account (Sec. 402A(e)(3)(B)). Otherwise, the excess amount will be distributed to the participant.
Under Sec. 402A(e)(4)(A), a plan may either offer to enroll participants in a PLESA or automatically enroll them.
If they are automatically enrolled, the PLESA contribution rate may not be more than 3% unless the participant affirmatively elects at any time to opt out or change the PLESA automatic contribution percentage. The participant may separately opt out of or change an automatic PLESA contribution percentage without affecting automatic contributions applicable to non-PLESA accounts.
The plan must allow participants to draw on their PLESA accounts at least monthly, without any limit on the number of PLESA withdrawals in a year or any restriction on the minimum PLESA balance. Under Secs. 402A(e)(7) and 72(t)(2)(J), the 10% early-distribution penalty under Sec. 72(t) does not apply to PLESA withdrawals. PLESA funds may be held only in a regulated financial institution and only in cash, in an interest-bearing savings account, or in certificates of deposit (CDs). No administrative fees are permitted on the first four withdrawals in a year, but reasonable fees are permitted thereafter (e.g., for use of paper checks) (ERISA §§801(c)(1)(A)–(C)).
Under Sec. 402A(e)(6), if the employer makes matching contributions under the plan, it is required to match PLESA contributions at the same rate as other plan matching contributions. The maximum annual PLESA matching contribution limit is the lesser of $2,500 (as indexed) or other amount designated by the plan sponsor (the same limit as for PLESA contributions). PLESA matching contributions must be credited to a designated account under the plan other than the PLESA (Sec. 402A(e)(6)(A)).
PLESA contributions must be aggregated for nondiscrimination testing purposes with elective contributions credited to non-PLESA accounts. If a participant exceeds the maximum annual contribution limit under the plan (i.e., for 2023, $22,500 under Secs. 402(g) and 457(b)(2) for cash-or-deferred arrangements and deferred compensation plans and $15,500 under Sec. 408(p)(2)(E) for SIMPLE IRA plans), the participant’s PLESA contributions must be distributed first (Sec. 402A(e)(9)).
Under ERISA Section 801(c)(2)(B), an employer may terminate a plan’s PLESA feature at any time. Upon a participant’s actual termination of employment, or employer termination, the plan must (1) allow a participant to transfer some or all of a PLESA account balance to another designated Roth account in the plan, and (2) for any amounts not so transferred, make such amounts available for distribution (Sec. 402A(e)(8)). No amounts from any other employer plan may be transferred into the PLESA.
PLESA in-service distributions may not be rolled over; however, PLESA amounts paid upon a termination of employment or the employer’s termination of the PLESA are eligible rollover distributions.
The plan sponsor is required to provide a PLESA disclosure notice (which may be consolidated with other required plan notices) not less than 30 days or more than 90 days prior to the first PLESA contribution, disclosing the terms of the PLESA (Sec. 402A(e)(5)(A)).
ERISA Section 802 provides that any state anti-garnishment laws that would prevent automatic contributions are preempted. Further, under an anti-abuse provision in Sec. 402A(e)(12), plans may implement procedures to prevent manipulation of the rules to cause matching contributions to exceed the intended amounts or frequency but without requiring suspension of matching contributions after a participant’s withdrawal.
Why do we need PLESAs?
Individual account plans are already permitted to provide in-service withdrawal provisions for certain emergency purposes that are exempt from the 10% early-withdrawal penalty, including expenses for:
- Personal emergencies up to $1,000 (as indexed for inflation) annually under Sec. 72(t)(2)(I), starting in 2024 under the SECURE 2.0 Act, Section 115;
- Domestic abuse up to $10,000 (or, if less, 50% of the account balance) under Sec. 72(t)(2)(K), starting in 2024 under act Section 314;
- Adoption or birth of a child up to $5,000 under Sec. 72(t)(2)(H);
- Qualified medical expenses and unemployed individuals’ health insurance premiums under Secs. 72(t)(2)(B) and (D); and
- Qualified disasters under Sec. 72(t)(11).
In addition, certain retirement plans may provide for hardship distributions due to an immediate and heavy financial need, although hardship distributions are generally subject to the 10% early-distribution penalty unless an exception, such as those mentioned above, applies. Moreover, the 10% early-distribution penalty does not apply to in-service withdrawals by participants who have attained age 59½ (or attained age 55 upon a termination of employment) or who satisfy certain other exceptions under Sec. 72(t)(2). Plans may also provide for participant loans for any reason, provided that the requirements of Sec. 72(p) are satisfied.
How are PLESAs different?
The purpose of an employer-provided retirement plan is to assist employees in funding their own retirements by accumulating tax-favored savings over the long haul, taking advantage of investment growth over time, subject to significant restrictions on taking the money out prior to retirement. PLESAs, on the other hand, are not retirement accounts. They allow participants to accumulate highly liquid, easily accessible funds for the purpose of paying short-term, emergency expenses. They are not intended to fund a participant’s retirement.
Accordingly, existing rules seek to preserve retirement savings by limiting in-service withdrawals to narrow factual situations, requiring participants to attest to those facts, imposing age or frequency restrictions, and, in some cases, imposing the disincentive of a 10% penalty. By contrast, PLESAs do not require any particular facts or even any self-certification by the participant establishing that an emergency exists. While Sec. 402A(e)(5)(A)(i) requires a PLESA notice disclosure to state that “the purpose of the account … is for short-term emergency savings,” “emergency” is not otherwise defined.
So, what are PLESAs doing in employer-provided retirement plans?
According to a Senate Finance Committee summary of SECURE 2.0, almost half of all Americans would struggle to pay an unexpected $400 expense. Many seek to cover even small emergency expenses by tapping into their retirement savings prior to retirement, for example, by taking a distribution from a prior employer’s retirement plan, upon termination of employment, or upon attaining age 59½. It is thought that easy access to PLESA funds may indirectly prevent “leakage” from participant retirement savings.
Further, the liquidity of PLESA funds may protect an employee from having to unexpectedly sell retirement account investments at a loss to cover emergency expenses in a down market. The monthly access to PLESAs may also be useful during periods of high inflation or unemployment by making available small amounts several times a year on an as-needed basis.
However, the feasibility of PLESAs remains to be seen. The adoption of a PLESA feature may not be for every employer. Because PLESAs must be held in cash, in a savings account, or in CDs, participants who for whatever reason fail to withdraw their after-tax money on account of an emergency may miss out on the greater investment earnings that the same contributions might have produced in another plan account. In this respect, while participant inertia under an automatic contribution feature may result in increased retirement savings, it may not be an advantage with respect to automatic PLESA contributions.
PLESAs also have the potential to increase administrative burdens and costs for plan sponsors in the following ways:
- In a plan with an eligible automatic contribution arrangement applicable to the PLESA, a new, separate PLESA account would have to be set up for each plan participant who fails to opt out.
- PLESA withdrawals as frequently as monthly might greatly increase the number of distributions that a third-party administrator would have to administer in a year.
- The requirement to hold PLESA contributions in cash, a savings deposit account, or CD may require new relationships with federally regulated financial institutions.
- The prohibition on a minimum PLESA balance may require employers to pay for maintaining additional accounts for active employees with very little money in them. The mandatory cash-out rules applicable to terminated vested employees with a vested accrued benefit of not more than $7,000 does not apply to the PLESAs of active participants.
- The crediting of matching contributions on PLESA contributions to a non-PLESA account in the plan may give rise to operational defects. The deemed increase in the contribution percentage of a non-PLESA account if the $2,500 maximum PLESA account balance is exceeded, and the potential transfer of PLESAs to another participant account in the plan upon termination of employment or the employer’s termination of the PLESA feature, may be prone to error and may unduly complicate nondiscrimination testing.
- PLESAs would require yet another participant notice.
While SECURE 2.0 does not require employers to offer PLESA accounts, plan sponsors who adopt them, in the absence of Treasury regulations, have little discretion over their operation. The act authorizes the Labor Department and Treasury to issue and coordinate on PLESA regulations and other guidance as needed, such as expanding IRS correction programs to PLESA failures, providing model plan language and PLESA notices, and managing interactions between PLESAs and safe-harbor 401(k) plans. The agencies are also charged with promulgating anti-abuse rules regarding the amount and timing of employer contributions. Employers may be wise to wait for such guidance before implementing a PLESA feature.
The Labor Department and Treasury will be required to conduct a study and report to Congress on various PLESA issues, including whether the $2,500 limit is sufficient; the extent to which plan sponsors voluntarily offer, and low- and middle-income households voluntarily participate in, PLESA accounts; the effect of PLESAs on retirement savings plan “leakage”; minimizing the compliance and reporting burdens applicable to PLESAs; and providing rules for default investments. The report is due not later than seven years after the date of enactment.
Mo Bell-Jacobs, J.D., is a senior manager with RSM US LLP. Contributors are members of or associated with RSM US LLP. For additional information about this item, contact Joni Andrioff, J.D. (Joni.Andrioff@rsmus.com), Washington, D.C., and Christy Fillingame, CPA (Christy.Fillingame@rsmus.com), Raleigh, N.C.