Although January is still in progress, 2025 has already seen some significant developments for sponsors and fiduciaries of retirement plans. The IRS and the Department of Labor have issued several pieces of important guidance, and retirement plan litigation continues to keep the courts busy. This newsletter highlights some developments of particular interest.
IRS Issues Catch-up Contribution Guidance
The IRS has issued long-awaited proposed regulations addressing changes made by the SECURE 2.0 Act to the rules for “catch-up contributions” (additional pre-tax or Roth payroll deduction contributions permitted for plan participants age 50 and older).[1]
Under the SECURE 2.0 rule, participants in a defined contribution plan (other than a SIMPLE plan) who are eligible to make catch-up contributions and who have FICA wages in excess of $145,000 (as indexed for inflation) or more for the previous year may only make catch-up contributions on a Roth basis. The rule was scheduled to take effect for 2024, but the IRS announced that it would not enforce the rule during an “administrative transition period” from January 1, 2024 until January 1, 2026, recognizing that payroll providers and plan recordkeepers needed both additional time and more information from the IRS in order to implement the rule. The proposed regulations provide details regarding how the rule will work. Among other things:
- The regulations allow a plan to establish a rule that all catch-up contributions for individuals covered by the Roth requirement are automatically Roth contributions, so long as an affected individual has the right to opt instead to discontinue contributions after reaching the non-catch-up deferral limit. However, a plan cannot require all catch-up contributions to be made on a Roth basis. Pre-tax catch-up contributions must be an option for those below the FICA threshold
- A plan is also permitted to establish a process whereby pre-tax contributions not originally known to be catch-up contributions (for example, in a situation in which a plan fails ADP testing and needs to recharacterize regular deferrals as catch-up contributions) automatically become Roth contributions when their status as catch-up contributions is ascertained. So long as a plan has processes in place that are designed to prevent violations of the statutory pre-tax contribution limit and provides for catch-up contributions to automatically be considered Roth contributions with respect to participants subject to the Roth mandate, correction of excess pre-tax contributions can be accomplished by treating the contributions as Roth contributions and reporting them accordingly on Form W-2, or via an in-plan Roth rollover. These options provide alternatives to needing to distribute pre-tax contributions in excess of the permissible non-catch-up elective deferral limit. A plan may allow for either or both correction methods, but must apply the same method to all participants whose contributions were in excess of a given limit for a particular year.[2] The deadline for correction will depend on which statutory limit necessitated the treatment of the contributions as catch-up contributions.
- The IRS also addressed the method of determining whether a person’s FICA wages exceed the $145,000 (as indexed) threshold, stating that wages are calculated with respect to the individual’s common law employer who sponsors the plan, that wages paid by different common law employers do not need to be aggregated (even if the employers are related and participating in the same plan) and that self-employed individuals and certain employees whose wages are not subject to FICA therefore are not subject to the Roth mandate.
- If a plan does not allow Roth contributions, the plan can bar individuals subject to the Roth mandate from making catch-up contributions even if it allows other individuals to make pre-tax catch-up contributions. The IRS explained that this will not violate the “universal availability” rule that in order to make catch-up contributions available to anyone, the plan must offer them to all age-eligible participants. In this situation, the permissible amount of catch-up contributions for individuals above the FICA threshold is $0. The IRS warned, however, that it is possible that this design could cause non-discrimination testing issues due to the limitation on access to catch-up contributions as a feature under the plan.
- If Roth catch-up contributions are permissible for individuals subject to the Roth mandate, the Roth catch-up option also has to be available to all other catch-up eligible participants.
- If a participant subject to the Roth catch-up mandate made both pre-tax and Roth contributions during the year, the regulations allow for flexibility in determining which contributions will be considered “catch-up contributions.” This allows Roth contributions to count towards the catch-up amount that must be classified as Roth contributions, even if those contributions were made before the participant exceeded the dollar limit on non-catch-up contributions.
- In addition, the IRS also addressed the problems the Roth requirement poses for plans that are qualified in both the U.S. and Puerto Rico, in light of the fact that Puerto Rico does not allow Roth contributions. The proposed regulations permit dual-qualified plans to satisfy the universal availability rule by permitting Puerto Rico participants subject to the Roth catch-up requirement to make after-tax contributions.
- The IRS retained the 2026 effective date for the Roth requirement, subject to potential extension for collectively bargained employees depending on the expiration date of their collective bargaining agreements.
SECURE 2.0 also added a provision allowing individuals who will be at least age 60 and no older than age 63 on December 31st of a year to make a larger amount of catch-up contributions. In 2025, the normal catch-up limit is $7,500, while individuals in the age 60-63 group can contribute $11,250. Much to the relief of plan sponsors and vendors who have struggled with implementing this feature, the IRS has confirmed that this feature is optional. A plan can offer regular catch-up contributions without being obligated to offer the ages 60-63 enhanced limit. The IRS also confirmed that a plan qualified in both the U.S. and Puerto Rico does not violate the universal availability rule by enforcing Puerto Rico’s lower catch-up limit for Puerto Rico participants.
IRS Issues Automatic Enrollment Guidance
Effective in 2025, newly established 401(k) and 403(b) plans with a deferral feature are required to include an automatic enrollment and contribution rate escalation feature, subject to limited exceptions. 401(k) and 403(b) plans in existence prior to December 29, 2022, are excluded from this requirement, and there are other exceptions for businesses with 10 or fewer employees, new businesses that have been in existence less than 3 years (including any predecessor employers), church plans, SIMPLE Plans, and governmental plans. For those organizations that are now subject to the automatic enrollment/automatic escalation requirement, the IRS has issued proposed regulations.
Under the proposed regulations, the automatic enrollment and escalation requirements will apply to all plan participants, even those who were hired prior to January 1, 2025, unless those participants have filed affirmative contribution elections (or affirmative elections not to contribute). Since this was not previously the expectation of affected employers, the IRS has allowed a transition period pending final regulations.
The proposed regulations reverse the position taken in interim IRS guidance that a pre-December 29, 2022 plan that merged into a multiple employer plan (MEP) or pooled employer plan (PEP) established on or after December 29, 2022 would lose its exemption from the automatic enrollment/escalation requirement. Under the proposed regulations, the merging employer’s plan population would remain exempt, even if other employers in the MEP or PEP are subject to the requirement. In addition, the IRS retained and expanded upon helpful provisions of the interim guidance addressing plan mergers and spin-offs, and provided clarifications regarding the other exemptions from the automatic enrollment/escalation requirements.
The proposed regulations also include conforming updates to the rules for permissible withdrawals under eligible automatic contribution arrangements.
Department of Labor Guidance
The Department of Labor has also been wrapping up projects related to SECURE 2.0.
- At the end of December, the Department activated a “Retirement Savings Lost and Found” database (https://lostandfound.dol.gov/). The database is intended to make it easier for participants and beneficiaries to identify plans which may owe them benefits and contact the plan administrator. The Department has asked employers to provide relevant participant information on a voluntary basis. However, given the legal restrictions and liability risks associated with disclosing personal information, an employer interested in doing so should consult counsel.
- The Department issued proposed regulations providing instructions on how employer stock in closely held companies should be valued for purposes of ESOP transactions, only to withdraw them as mandated by the regulatory freeze imposed by the incoming Trump administration. If the regulations are re-issued as drafted, a retirement plan seeking to purchase employer stock would need to ensure it does not pay more than “adequate consideration,” and likewise must ensure that it receives “adequate consideration” if it sells the securities. The Department originally issued proposed regulations on this topic in 1988, but never finalized them.[3] This has been an area of extensive litigation, and SECURE 2.0 directed the Department to issue regulations to provide clarity to plans and other parties to employer stock transactions as part of an initiative to facilitate employee ownership of businesses. Accordingly, practitioners hope that the regulatory process will resume and provide some badly needed clarity in this area. Among other topics, the proposed regulations addressed the selection and use of professional independent valuation advisors, circumstances in which payment of a “control premium” is and is not appropriate, the application of discounts reflecting the lack of marketability, and the need for “prudent consideration of the issuer’s ability to meet its stock repurchase obligations, comply with its contribution obligations, and meet any debt or other obligations on the terms established in connection with the transaction.”
The Department has also released other pieces of guidance.
- In Field Assistance Bulletin 2025-1, the Department announced a temporary enforcement policy reversing its prior position that ongoing plans cannot escheat benefits owed to missing individuals to state unclaimed property funds. The new policy allows plans to escheat benefits valued at $1,000 or less (disregarding plan loans) to the unclaimed property fund for the state of the payee’s last known address if the payee cannot be found after a diligent search and certain other conditions are met. Some of those conditions pertain to characteristics of the unclaimed property fund, such as requiring the fund not to reduce payments by fees or other charges and to allow claims in perpetuity regardless of when money was received by the state. However, the plan’s summary plan description also must explain that “retirement benefit payments of missing participants or beneficiaries may be transferred to an eligible state fund” and provide contact information for a plan representative who can provide further information. The FAB also includes a general requirement that the fiduciary determine that the unclaimed property fund is a prudent destination for the money, without providing a safe harbor for this determination. Ultimately, it remains to be seen how useful this policy will prove to plan fiduciaries struggling to resolve unclaimed benefits situations.
- The Department has reissued its Voluntary Fiduciary Correction Program (“VFCP”), which allows plan fiduciaries to obtain regulatory approval and penalty relief for certain types of compliance violations.
- The new version of the program will allow self-correction of late remittances of elective deferrals and loan repayments withheld from participant paychecks which meet the self-correction program’s requirements, eliminating the previous requirement to file an application with the Department for formal approval of the correction. The self-correction process will, however, require the filing of an electronic notice of the incident with the Department, and retention of specified documentation, including a certification (under penalty of perjury) by the plan fiduciary, as well as the payment of the contributions and loan amounts to the plan along with reimbursement for investment earnings lost due to the delay. Self-correction is available for lost remittance situations in which remittance is completed within 180 days and which involve $1,000 or less in lost earnings, assuming the other criteria for use of the VFCP are met. The self-correction process for calculating lost earnings differs somewhat from the correction process used in connection with a formal application, with the intention that the self-correction process provide for a more streamlined and definitive lost earnings calculation.
- The new version also includes a self-correction feature for certain participant loan issues corrected under the IRS’ Employee Plans Compliance Resolution System.
- In addition, the revised program features some simplifications, clarifications, and other revisions to the details of some of the transactions listed as eligible for correction, as well as some procedural changes and revisions.
American Airlines ESG Case
In Spence v. American Airlines, the plaintiff alleged that American Airlines improperly managed its 401(k) plan investments with an eye towards fulfilling “environmental, social and governance” (“ESG”) goals favored by the company rather than acting in the economic best interests of plan participants as required by the Employee Retirement Income Security Act (“ERISA”). The original lawsuit challenged a number of investments available under the plan’s brokerage window, but the lawsuit eventually was pared down to a focus on the BlackRock funds available under the plan and BlackRock’s ESG-oriented proxy voting activities, and in particular challenged a proxy vote with respect to Exxon which was followed by a drop in stock price.
Regardless of their views on the business merits of “ESG” investing, practitioners have expressed concern that this case may encourage politically motivated challenges to particular managers or merely because of a plan sponsor’s known views on ESG or other potentially controversial topics. Notwithstanding these concerns, the court allowed the case to proceed past a motion to dismiss and then a motion for summary judgment, and held a trial last year. The judge in the case is known for politically conservative views, and his opinion included a lengthy critique of the investment industry in general and BlackRock’s ESG activities. However, the judge conceded that American Airlines and the plan fiduciary committee were acting in keeping with industry norms when it came to the process for selecting and overseeing plan investments, and concluded that the decision to retain the BlackRock funds did not breach their duty of prudence.
However, the court noted that BlackRock was a major shareholder and lender for American Airlines, and that the American Airlines employee charged with overseeing plan investments was also the corporate liaison to BlackRock as shareholder. The court described other indications of entanglement between American Airlines and BlackRock, and highlighted internal communications regarding ESG investing in connection with the plans. The court concluded that American Airlines had breached its fiduciary duty of loyalty. The court also observed that BlackRock was one of the largest shareholders in Aon, the investment consultant that worked with the committee to evaluate and select investment options, and that Aon therefore also operated under the potential for conflicts of interest.
The court has yet to determine whether American Airlines’ breach of loyalty caused any financial harm to the plan. A separate proceeding will be held to answer that question. Nor did the court provide any clear indications as to what American Airlines should have done that might have protected it against suit or resulted in a better outcome for the plan. While the court suggested at various points that American Airlines or Aon should have engaged with BlackRock’s proxy voting process at more length and noted American Airlines’ failure to collect the certifications of compliant proxy voting that BlackRock was contractually obligated to provide, it is not clear to what extent further inquiries by a single plan could have been expected to cause BlackRock to do something different. Indeed, the court conceded that it is not normal for plan fiduciaries to engage in detailed review of fund managers’ voting activities. Furthermore, it is not clear why American Airlines should have identified any cause for concern, much less one that rose to the level of requiring action. The court conceded that the American Airlines fiduciaries acted prudently in determining that the BlackRock investments were suitable choices for the plans as a general matter based on normal industry criteria, and observed that other large investment managers had taken actions similar to the challenged BlackRock actions, and that other plans’ fiduciaries had not raised any objections to these actions. In fact, given that the BlackRock funds’ investment performance was satisfactory based on prevailing standards for investment analysis, it is questionable whether it would have been prudent for the American Airlines fiduciaries to attempt to interfere, regardless of their views on the merits of ESG or their corporate ties to BlackRock.
The American Airlines case is a single case decided by a judge who openly expressed disapproval of ESG programs, and who also focused on the potential for conflicts of interest in light of the challenged investment manager’s corporate dealings with the particular plan sponsor. Since the judge nonetheless ruled in favor of American Airlines on the plaintiff’s claims of breach of the fiduciary duty of prudence based on the fiduciaries’ adherence to normal industry practices in terms of the method and degree of oversight, fiduciaries of other plans can take some comfort in the expectation that adhering to established best practices for selecting, overseeing, and replacing investments should offer protection against an ultimate finding of fiduciary liability. Hopefully, this aspect of the ruling will also discourage plaintiffs’ attorneys from targeting plans merely because they offer BlackRock funds (as many do, with BlackRock being the largest asset manager in the world) or funds of certain other managers who have been known in the past to pursue ESG goals.[4]
That said, fiduciaries of plans which include explicitly ESG-themed investments as part of a fiduciary-managed portfolio and/or as investment options on the plan’s “core” investment platform should take special care to be sure those investments satisfy ERISA. As noted above, in keeping with regulatory precedent dating back decades, an investment can be selected and retained in a plan only so long as the investment is in the economic best interests of plan participants, regardless of other considerations. An ESG investment (or other special themed investments, such as funds designed to satisfy certain religious restrictions) thus must merit inclusion based on its performance as measured using a typical economic analysis.[5] It is worth noting, as well, that there is no exception to this requirement merely because participants have requested an ESG or other themed option, although fiduciaries can take participant preferences into account when determining whether to add an economically prudent investment.[6]
Regardless of the presence (or lack) of ESG investments, fiduciaries should also take the adverse ruling with respect to the duty of loyalty as a reminder to be sensitive to their own and their vendors’ potential conflicts of interest and adopt appropriate mitigation strategies. Conflicts can arise due to a variety of situations, and remain a popular target for plaintiffs’ attorneys. For example, in 2024, United Healthcare settled a challenge to its decision to offer Wells Fargo target date funds in its 401(k) plan for $69 million. The plaintiffs had alleged (and provided internal communications that demonstrated) that United Healthcare was motivated by concerns to retain Wells Fargo as a customer and banker. Conflicts of interest have also been significant allegations in cases challenging various pension plan annuity contract purchases. For example, plaintiffs have alleged that State Street’s role as independent fiduciary in various cases was compromised by its investments in the plan sponsor and/or the insurance carrier.
In addition, fiduciaries should be sure that their vendors are adhering to contractual reporting obligations, with respect to proxy voting and otherwise, and review (or have their consultants review) the documentation provided. While the American Airlines court conceded that fiduciaries are not expected to analyze every vote, fiduciaries should at least take steps to confirm that their managers have instituted voting policies that are designed to comply with ERISA, and that periodic due diligence (whether conducted by the fiduciaries themselves or by their consultants) includes receipt of confirmation from the managers that their votes have complied with their policies.
As always, please feel free to contact a member of the Employee Benefits and Executive Compensation group for more information about the items discussed in this newsletter.
[1] The proposed regulations also address increased limits for SIMPLE plans.
[2] Since use of the first method would not be permissible if Form W-2 had already been issued for the relevant year, the IRS acknowledged that this method likely will not be useful for ADP test corrections. ADP testing normally will not be completed in time to allow Form W-2 to reflect Roth reclassification in response to testing results.
[3] The Department has withdrawn the 1988 proposal in conjunction with this new regulation, but noted that the new proposal addresses only the valuation of employer stock for ESOP transactions, while the 1988 proposal had a broader scope. The Department requested comments on whether it “should conduct notice-and-comment rulemaking with respect to a broader range of assets (i.e., assets other than employer stock)” and added that, “Pending a decision on this issue, the Department does not intend to contest parties’ reasonable and good faith reliance on the 1988 proposal in situations that fall outside the current proposal.”
[4] Of potential relevance for ongoing evaluations of the prudence of BlackRock investment, BlackRock recently settled a lawsuit involving allegations by Tennessee that it had made misleading statements regarding the impact of its ESG activities on non-ESG funds. BlackRock reaffirmed its position that it has always voted in the best interests of fund shareholders but agreed to increased disclosure surrounding proxy voting, committed not to coordinate or communicate outside the firm with respect to its voting intentions, and agreed not to use ESG ratings for non-ESG funds.
[5] More information about the current regulations governing ESG investments is available in our newsletter at https://hselaw.com/news-and-information/legalcurrents/department-of-labor-issues-replacement-final-regulations-regarding-proxy-voting-and-esg-investing-by-benefit-plans/. Those rules are currently facing a legal challenge in front of a different Texas district court judge. Although he upheld the regulations initially, that decision was remanded for reconsideration in light of the 2024 Supreme Court decisions reducing the level of deference that courts are required to afford to agency regulatory actions.
[6] Fiduciaries who want to accommodate participants’ desire for a broader range of investment options can consider whether a brokerage window would be a prudent method of doing so. Although the Spence case initially challenged alleged ESG options available through the brokerage window, the plaintiff discontinued those claims, apparently conceding the currently accepted premise that plan fiduciaries cannot be expected to monitor thousands of mutual funds and potentially other securities (depending on the brokerage design) to ensure that they all represent economically sound choices. Attempting to do so would not only defeat the intention that offering a brokerage account enhance participants’ ability to choose investments that meet their individual needs; it would be doomed to failure from the sheer scale of the logistical obstacles. However, plan fiduciaries should bear in mind that while the Department of Labor has not offered comprehensive guidance regarding the scope of obligations to oversee brokerage windows, it has asserted that the general duty of prudence applies to assessing whether a given brokerage option is appropriate and cost-effective for a plan. The Department also has suggested that at least in some cases, fiduciaries may have some obligation to set some sort of parameters for investments, most notably in connection with a Compliance Assistance Release disfavoring cryptocurrency offerings in participant-invested retirement plans (https://www.dol.gov/agencies/ebsa/employers-and-advisers/plan-administration-and-compliance/compliance-assistance-releases/2022-01/).