Pension-Linked Emergency Savings Accounts (“PLESA’s”) are the first-ever tax-favored vehicle for short-term, non-retirement savings. Introduced by SECURE Act 2.0, they will become available for inclusion in plans starting with plan years beginning in 2024. This post summarizes the rules that apply to PLESA’s, their advantages and drawbacks, and some issues that may not be immediate apparent on a first reading of the new law.
A PLESA is a species of Roth account funded solely by employee contributions. As with any Roth account, contributions are not excluded from taxable income. Unlike other Roth accounts, distributions are wholly tax-free under all circumstances. (Ordinarily, earnings attributable to Roth contributions are taxed upon withdrawal before age 59½, death or disability or within five years after the first contribution to the account.)
PLESA’s must be part of a plan that accepts elective deferrals: a 401(k) plan, a 403(b) plan or a governmental eligible deferred compensation (457(b)) plan. They cannot stand on their own or, despite what their moniker might suggest, be embedded in a pension plan or a non-401(k) profit sharing or stock bonus plan.
The employer may freely specify which employees are eligible to contribute to PLESA’s, imposing any desired age, service or other requirements, but highly compensated employees may not participate, and a nonhighly compensated employee who becomes highly compensated must stop contributing, though he may retain his account. In 2024, employees who earned over $150,000 from the employer in 2023, or who were more than five percent owners in either 2023 or 2024, will fall into the “highly compensated” group.
Contributions are limited. A participant may contribute no more than $2,500 (or a lower amount specified by the plan) minus his current account balance. If the balance is $2,000, he can put in up to $500. If it is $2,500 or more, he can contribute nothing until and unless the balance falls below the ceiling. The value of the account may exceed the ceiling only as the result of investment returns.
The contribution limitation will be indexed in $100 increments after 2024. If, for instance, inflation in 2024 is between 4.00 and 7.99 percent, the limitation in 2025 will be $2,600.
PLESA’s may invest only in interest-bearing bank accounts, money market funds, stable value funds and other vehicles that carry no appreciable risk of loss of principal. That means that they won’t grow speedily and spectacularly. On the other hand, participants can be confident that money set aside for emergencies will be there, regardless of the investment climate.
A plan may include an automatic contribution arrangement for PLESA’s, whereby a specified percentage of pay (not more than three percent) will be deducted automatically from participants' paychecks and transferred to their PLESA’s, unless they choose a different contribution percentage (including zero). Automatic contributions have become popular as a way to prod employees to save more for retirement. Whether there will be the same interest in nudging them to put aside funds for unanticipated expenses is uncertain.
Withdrawals must be allowed at any time for any reason, though the plan can restrict them to no more than one a month and can charge reasonable processing after a participant’s fourth withdrawal in any plan year. As already mentioned, withdrawals are entirely free of tax. The limited investment options mean, of course, that the earnings included in a withdrawal will rarely be large, and withdrawn principal, never having been excluded from income, would in any event not be taxed again.
Perhaps realizing that the exclusion of earnings from taxable income might be an insufficient incentive for PLESA contributions, the architects of the statute added another benefit: The employer must match PLESA contributions at the same rate as participants would receive on their elective deferrals. If, for instance, a 401(k) plans matches 50 percent of deferrals that don’t exceed six percent of compensation, the same match must apply to PLESA contributions. A participant who earns $50,000 a year and contributes $1,500 to his PLESA must receive a matching contribution of $750. Elective deferrals and matching contributions are aggregated in calculating the match. If the participant also deferred $3,000 (six percent of compensation), his total match would be $1,500 (50 percent of $3,000), not $2,250 (50 percent of $4,500).
The matching contributions go not into the PLESA but into the same account as other matching contributions, where they are subject to that account’s withdrawal restrictions and tax treatment. In effect, PLESA savings get an immediate, if not instantly accessible, 50 percent return on investment.
This attractive feature generates some complications.
What is to prevent a participant from contributing to his PLESA, receiving a matching contribution, withdrawing the PLESA contribution, then contributing to the PLESA again to get another match on the same money? To illustrate, Cagey Jake contributes $500 in January. His employer, which makes matching contributions each month, adds $250 to his matching contribution account. Jake withdraws $500 from the PLESA in February, immediately recontributes it and gets another $250 match. The game can go on until he has obtained the maximum match that the plan allows, without his being a dime out of pocket.
In response to such schemes, SECURE Act 2.0 allows plans to “employ reasonable procedures to limit the frequency or amount of matching contributions with respect to contributions to such account, solely to the extent necessary to prevent manipulation of the rules of the plan to cause matching contributions to exceed the intended amounts or frequency”. Fine, but what will those “reasonable procedures” be? It may be very difficult to devise them.
The first idea that comes to mind is to delay PLESA-related matching contributions until after the end of the year and to match only net contributions after withdrawals. That would inhibit Cagey Jake but not frustrate him entirely.
Suppose that he contributes $2,500 during 2024 and waits until January 2025 to take the money out. He will receive a $1,250 matching contribution for 2024. He won’t be able to accumulate more than $100 of net contributions in 2025 (assuming that the contribution limitation rises to $2,600), but he is free to start 2026 with an empty PLESA and get a “free” match for that year. No simple way to thwart that maneuver is evident.
Although all PLESA contributions are made by nonhighly compensated employees and therefore raise no nondiscrimination issues in and of themselves, they play a role in 401(k) and 403(b) nondiscrimination testing (other than for plans that avoid testing through the use of nondiscrimination safe harbors).
Although the SECURE Act’s text is muddier than one would like, it appears that PLESA contributions are included in the ADP test in the same manner as elective deferrals. Since only nonhighly compensated employees can make them, the upshot will be higher deferral percentages for the NHCE group and a greater likelihood of passing the test.
Similarly, matching contributions based on PLESA contributions are included in the ACP test and improve the test results there.
A few other points to note about PLESA’s:
An employer that changes its mind about offering a PLESA feature may eliminate it at any time for some or all participants; it isn’t protected by the anti-cutback rule. Participants then may either transfer their PLESA balances to other Roth accounts in the plan or receive them as distributions, which may be transferred to a Roth IRA by direct rollover.
Participants who terminate employment likewise have the choice of transferring their PLESA’s to other Roth accounts, receiving them or making direct rollovers to Roth IRA’s.
The statute includes a fairly lengthy list of disclosures about how PLESA’s operate that must be given to eligible employees at least 30 days (bur not more than 90) before their first contributions and annually thereafter. The IRS and DOL are authorized to provide model notices, and perhaps they will.
What are the prospects for this innovation? It will certainly be attractive to employees, who will be able to put money into a tax-favored vehicle with losing convenient access to it for years and years. To the extent that PLESA contributions are added to, rather than hived off from, elective deferrals, they will increase matching contributions, a plus for retirement savings but also an additional cost to employers. The most severe and intractable obstacle to acceptance is the possibility of abusive in-and-out contribution schemes, which could prove very costly and immune to preventive measures.
References: ERISA §§801 through 804 and IRC §402A(e), as added by Pub. L. No. 117-328, Div. T, §127
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