This Client Action Bulletin reviews the increase to the mandatory cash-out limit under the SECURE 2.0 Act of 2022 for tax-qualified, employer-sponsored defined benefit (DB) and defined contribution (DC) plans, discusses some considerations for adopting the change, and notes the possible restrictions that could limit the ability of some DB plans to make the change.

March 8, 2024 Update: IRS issued Notice 2024-2 in December 2023 extending the deadlines for plan sponsors to adopt required and discretionary plan amendments related to SECURE 2.0. Changes to this article are shown in green.

Mandatory distributions

Plan sponsors can add a provision to their plans to cash out small, vested benefit amounts up to the statutory limit. These mandatory distributions can be paid out without the consent of the participant or their spouse and are paid prior to the participant’s annuity starting date.

“Mandatory” is a bit misleading because it sounds like plans must make this change. Adopting the higher $7,000 limit is optional. In fact, plans don’t have to have a mandatory distribution provision at all.

Plans with a mandatory distribution provision must notify participants or beneficiaries if their benefit will be cashed out, giving them the option of how they will receive the money. Lump sum amounts below $1,000 can be paid out to the individual in cash but amounts above $1,000 must be rolled over to a designated IRA of the plan sponsor’s choice if the individual does not otherwise specify how they want to take the money.

• The lump sum paid from a DB plan cannot be less than the present value of the normal retirement benefit calculated using the applicable mortality and interest rates prescribed under Internal Revenue Code (IRC) 417(e). Higher amounts may be paid if a plan specifies alternative assumptions for calculating lump sums or elects to include the value of an early retirement subsidy when calculating the lump sum amount.
• For DB plans, higher interest rates result in smaller present values. The recent increase in interest rates, coupled with a $7,000 limit, could make some previously ineligible participants eligible for mandatory distributions.

Is this change a good idea?

Plan sponsors may want to consider the following when deciding whether to make this change:

• Missing participants: Most participants with small benefits are younger, with shorter service. Plan sponsors choosing to increase the cash-out limit may pay these individuals out years before retirement, eliminating the need to track them and reducing the chance they become missing participants.
• Reduced costs: When the plan pays out the lump sum, the participant no longer has any claim for future benefits. As a result, it is no longer necessary to send these former participants periodic benefit statements or plan notices.
• PBGC premiums: DB plans pay annual premiums to the Pension Benefit Guaranty Corporation (PBGC), the federal agency that insures these plans. For the 2023 plan year, the annual premium for multiemployer DB plans is $35 per participant, while single employer DB plans pay $96 per participant plus a variable rate premium of 5.2% of the plan’s unfunded vested benefit liability (up to the $652 per participant cap). Increasing the cash-out limit may help lower PBGC premiums.
• Retirement leakage: Individuals receiving these small mandatory distributions may be more likely to elect to receive the money in cash rather than roll it over to an IRA or another qualified retirement plan. If these individuals choose to accept their benefits in cash, it could impair their future retirement security.

Is your plan restricted from making the change?

Plan sponsors of DC plans are not restricted from making this change.

However, for some DB plans, the lump sum value of the monthly annuity may be higher than the present value of the same benefit based on the assumptions used for the annual actuarial valuation, resulting in higher liabilities if the change is made. Plan sponsors should engage in discussions with the plan actuary and plan counsel to determine if such liability increases may be restricted for the following plans, thereby not allowing for amendments increasing to the higher limit.

Multiemployer plans that are not in the Green Zone

Generally, from the date the plan is first certified in endangered, seriously endangered, critical, or critical and declining status until the plan’s board of trustees adopt an improvement plan (the plan adoption period), the law prohibits plan amendments that increase liabilities by reason of any increase in benefits unless such amendment is required to maintain the plan’s tax-qualified status.

After the plan adoption period, the plan may not be amended to increase benefits unless the plan actuary certifies that the increase is paid for with additional contributions not contemplated by the improvement plan, and:

• If the plan is endangered or seriously endangered, it is still reasonably expected to meet the applicable benchmarks of its funding improvement plan.
• If the plan is in critical or critical and declining status, it is still reasonably expected to emerge from critical status by the end of the rehabilitation period as scheduled.

Multiemployer plans with IRC 431(d) amortization extensions

Plans that previously received approval from the IRS to extend certain amortization bases related to their unfunded actuarial liability under IRC Section 431(d) are subject to more stringent benefit improvement restrictions. No amendment that increases liabilities by reason of any increase in benefits may be adopted during the period the amortization extensions are in place.¹ If such an amendment is adopted, then the plan will lose its extensions for plan years on or after the date the amendment is adopted. Plans can apply to the IRS to keep their extensions if the amendment provides only a de minimis increase in liabilities.

Plan counsel should opine on whether increasing the cash-out limit from $5,000 to $7,000 could be considered an increase in benefits. If the change is deemed an increase in benefits, it may still meet the requirements of a de minimis increase in liabilities. In such cases, the plan may want to apply to the IRS for approval of the amendment to avoid any risk of losing the amortization extensions.

Multiemployer plans that elected funding relief under ARP

Plans that elected certain funding relief provided by the American Rescue Plan Act of 2021 (ARP) are also subject to restrictions on benefit increases.

• Plans that elected longer amortization of experience losses due to COVID-19, extended asset smoothing of investment losses during either or both of the first two plan years ending after February 29, 2020, or the widened asset corridor during that same two-year period may not allow plan amendments increasing benefits to go into effect during either of the two plan years following the year relief applies, unless the actuary certifies that the increase is paid for with additional contributions not allocated to the plan immediately before the election was made, and the plan’s funded percentage and projected credit balances for those two years are reasonably expected to be as high as they would have been had the benefit increase not been adopted.
• Plans that received special financial assistance (SFA) are prohibited from adopting benefit increases attributable to past service for the first 10 years after the plan receives SFA. After the first 10 years, through the plan year ending in 2051, the plan may request PBGC approval for the change by demonstrating that the plan will avoid insolvency after the amendment.

Single employer plans less than 80% funded

Plan amendments that increase liabilities by reason of increases in benefits cannot take effect in a plan year if the adjusted funding target attainment percentage (AFTAP) for the plan year is less than 80% or would be less than 80% if the amendment were taken into account in calculating the AFTAP. However, the restriction could be avoided if the plan sponsor paid for the benefit increase, or either burned credit balances or contributed the amount necessary to bring the AFTAP up to 80%.

Amending your plan

Plans must operate as if the optional change is in effect from the effective date chosen by the plan sponsor, but no earlier than January 1, 2024. If implemented prior to December 31, 2026 (December 31, 2028, for collectively bargained plans, or December 31, 2029, for most governmental plans), the amendment must be made by December 31, 2026 (2028 or 2029). If implemented after December 31, 2026 (2028 or 2029), the amendment must be made by the end of the plan year in which the change is effective. A full summary of the amendment deadlines can be found here.

Please contact your Milliman consultant to discuss how these provisions may impact your plan(s).

¹ IRC Section 412(c)(7).