The Secure Act 2.0, enacted in 2022, a massive piece of legislation with close to 100 provisions affecting defined contribution plans, defined benefit plans, and IRAs. The Act includes a new way for participants of defined contribution plans to amass emergency savings. For individuals who want to prioritize building emergency savings but can’t afford to do so while also saving for retirement, a new funding method allows them to take advantage of employer matching contributions in a way that would otherwise be unavailable. Beginning in 2024, Plan Sponsors of 401(k), 403(b), and governmental 457(b) plans may offer plan participants a “pension-linked emergency savings account” (PLESA) under Section 127 of the Act.
PLESAs deviate from traditional rules of when retirement funds can be accessed and distributed, by offering plan participants the option to withdraw all, or a portion, of their PLESA funds monthly. Furthermore, participant contributions to a PLESA are required to be made on a Roth basis, and pre-age 59 ½ distributions would not be subject to the 10% early distribution penalty.
PLESAs aren’t standalone accounts. Instead, they must be linked to a defined contribution retirement plan. In other words, an individual cannot establish a PLESA if they don’t have access to a defined contribution plan. Starting January 1, 2024, Plan Sponsors may (it’s not required) add a PLESA to their retirement plans.
PLESAs, like other types of retirement plan features, are subject to myriad rules including employee eligibility, funding contribution limits, distributions, rollovers, and more. Here, I will discuss what we know and don’t know (yet) about PLESAs. There are several open questions requiring IRS and or Department of Labor guidance.
Participant Eligibility: PLESA eligibility requires retirement plan participants to first satisfy age, service, and other eligibility requirements as necessary. Importantly, Only Non-Highly Compensated Employees (NHCE) are eligible to fund a PLESA. In other words, Highly Compensated Employees (HCE)1 are ineligible to contribute (even if plan eligibility requirements are met). A NHCE, who otherwise satisfies age, service, and other eligibility requirements under the plan, may contribute to a PLESA. Notably, a participant who becomes a HCE after contributing to a PLESA may not make any additional contributions but may still distribute their PLESA funds according to applicable withdrawal rules.
Employee Enrollment: A plan electing to offer a PLESA can have eligible participants:
1) Enroll in a PLESA, or
2) Be auto-enrolled up to 3% of an eligible participant’s compensation, unless the participant elects a lower rate of contributions or opts out.
The plan must provide a notice between 30 to 90 days prior to the date of a participant’s first contribution and not less than annually thereafter. The notice must contain specific information including the purpose of the PLESA, contribution limits, tax treatment, investment options, and more.
Contributions and Limits: PLESAs can only accept employee deferrals. Furthermore, participant contributions must be made on a Roth basis and are limited to a maximum of $2,500 (adjusted for cost-of-living adjustments) or lower as determined by the plan sponsor. In other words, participant contributions cannot cause their PLESA balance to exceed $2,500 (excluding associated earnings). Should participant PLESA contributions exceed the $2,500 maximum (or lesser amount set by plan), and a participant has a Roth account (under the plan), the plan may provide that the participant can elect to increase their contributions to their Roth account. In other words, the participant is deemed to have elected to increase their contributions to their Roth account at the rate at which contributions were being made to their PLESA. If, however, the participant does not have a Roth account (under the plan), PLESA contributions must cease. PLESA is not permitted to have a minimum contribution or account balance requirement.
Importantly, it appears PLESA contributions are counted toward the annual employee elective salary deferral limit ($22,000 for 2023). Therefore, if a participant contributes to a PLESA, that amount will reduce the amount that can be contributed as a salary deferral.
Employer contributions (match, profit sharing, etc.) to PLESAs are not permitted. However, where a plan makes matching contributions (to the traditional retirement plan), participant contributions (to their PLESA) must be matched at the same rate as any other matching contribution that are based on employee salary deferral contributions, provided the match on PLESA contributions is capped at $2,500, or the PLESA contribution limit set by the plan, if less, for the plan year. Notably, employer-matching contributions based on participant contributions to PLESAs must be made to the “traditional” matching account (not the PLESA). In other words, participant PLESA contributions are treated as salary deferrals for purposes of matching contributions.
The Act provides that plans may implement reasonable procedures ensuring PLESAs are not abused by participants who fund their PLESA qualifying for an employer matching contribution and subsequently distributing such funds. The IRS has been directed to issue guidance regarding how such restrictions would apply.
Investments: PLESAs, although required to be “linked” to a retirement plan, are similar to a savings account because the Act requires PLESAs to be held in a limited number of principally protected investments. Furthermore, a plan must accept contributions in any amounts.
Allowable PLESA investment options include cash in an interest-bearing account or investment product that is designed to preserve principal, will provide a reasonable rate of return, and is offered by a state or federally regulated financial institution.
Distributions and Rollovers: Government rules generally restrict a participant’s ability withdraw funds from a 401(k) plan prior to a qualifying event such as retirement, separation of service, or financial hardship. PLESAs do not require a participant to satisfy a “triggering” event to be distribution eligible. Furthermore, there is no requirement that distributions are allowable only in cases of emergency. Instead, there is no requirement that a participant provide a certification or determination of a financial emergency or hardship.
Distributions from a qualified retirement plan or IRA are generally subject to a 10% early withdrawal penalty when taken before attaining age 59½ unless an exemption applies. Distributing funds from a PLESA prior to age 59½ is not subject to the 10% early withdrawal penalty tax.
Other key PLESA distribution requirements:
- Distributions must be made as soon as practicable following the election.
- Participants must be able to make partial or full withdrawals for any reason, at least monthly.
- Participants’ first four withdrawals each plan year may not be subject to any fees, but subsequent withdrawals in a plan year may be subject to reasonable fees.
- Distributions are treated as “Qualified Distributions” for the purpose of Roth taxation rules. Therefore, a withdrawal (including any associated earnings) is distributed tax and penalty free.
- There is no indication of how distributions will be allocated to principal (contributions) and earnings. IRS guidance is needed.
- Distributions are not treated as eligible for rollover unless the distribution is in connection with termination of employment or termination of the PLESA (initiated by the plan sponsor).
- Upon separation from service, a participant has the option of distributing their PLESA as cash or rolling over the funds into a Roth account.
- The 10% penalty tax does not apply to PLESA distributions that are rolled into another Roth account, even if such PLESA contributions have not been held in the Roth account for the normally required five-year period.
- Distributions are treated as satisfying rules that restrict in-service distributions.
- PLESA may be terminated by the plan sponsor at any time. Upon termination of a participant’s employment or the PLESA by plan sponsor, the plan must allow the participant to elect to transfer their PLESA to another Roth account under the plan, and for any amounts not transferred, distributed to such employee.