Implementing SECURE 2.0’s Roth provisions may tax DC plan sponsors 

April 11, 2023
The SECURE 2.0 Act of 2022 (Div. T of Pub. L. No. 117-328) sets the stage for a considerable expansion of Roth savings in defined contribution (DC) plans. Starting in 2024, the law limits high-earning employees to making catch-up contributions solely on a Roth basis, effectively requiring most DC plans that allow catch-up contributions to have a Roth feature. DC plan sponsors can also let employees choose to receive employer matching and nonelective contributions on a Roth basis. Other provisions eliminate predeath required minimum distributions (RMDs) from Roth accounts, introduce Roth-based emergency savings accounts within DC plans, and expand Roth features for simplified employee pensions (SEPs) and savings incentive match plans for employees of small employers (SIMPLE plans). Agency guidance is needed to implement these provisions, but employers that don’t offer Roth features may want to start talking with their ERISA counsel and recordkeeper about doing so.

Characteristics of Roth contributions

DC plans, such as 401(k) and 403(b) plans, can offer a qualified Roth contribution program that lets employees make some or all of their elective deferrals on a Roth basis.

Employee election required. An employee must be able to elect between pretax and Roth contributions. A plan can’t offer only Roth contributions (but employers can auto-enroll employees on a Roth basis). An employee’s Roth contribution election must be irrevocable and can’t apply to contributions made to the plan before that election is effective. Plans must allow employees to make or change Roth elections for future contributions at least once per plan year.

Taxation of Roth contributions. Unlike pretax deferrals, Roth contributions are includable in an employee’s income when made. A plan must hold each employee’s Roth contributions and associated earnings in a separate designated Roth account. Roth contributions count toward an employee’s Section 402(g) annual deferral limit, as well as the additional catch-up limit for employees age 50 and older.

Taxation of Roth distributions. The taxation of a Roth distribution depends on whether it is a qualified distribution. If a distribution is qualified, the entire amount — including earnings — is tax-free to the employee. If the distribution is nonqualified, the portion attributable to the employee’s contributions is tax-free (since they were already taxed), but the earnings are taxable. In general, a distribution is qualified if at least five consecutive tax years have passed since the employee’s first Roth contribution to the plan, and the employee has reached at least age 59-1/2, died or become disabled.

Mandatory Roth-only catch-up for high earners

DC plans can allow employees age 50 and older to make catch-up contributions above the otherwise-applicable deferral limit (e.g., the Section 402(g) deferral limit or a lower limit set by the plan). Catch-up contributions are limited to an annually indexed dollar amount ($7,500 in 2023). Before SECURE 2.0, plans could allow all employees to choose whether to make their catch-up contributions as pretax deferrals or designated Roth contributions. However, starting in 2024, high-earning employees participating in 401(k), 403(b) and governmental 457(b) plans can make catch-up contributions only on a Roth basis (these employees can continue to make noncatch-up contributions on either a pretax or Roth basis). The act exempts SEPs and SIMPLE plans from this requirement.

Key elements of mandatory Roth catch-up. Sponsors and recordkeepers will face a number of implementation challenges. Administering this provision will require enhanced coordination between the sponsor’s payroll provider and recordkeeper, so sponsors may want to start talking with their providers now to prepare for next year.

  • High-earner threshold. The Roth catch-up mandate applies to any employee whose wages subject to Federal Insurance Contributions Act (FICA) taxes in the prior calendar year from the employer sponsoring the plan exceeded $145,000, indexed after 2024. This standard differs from the threshold when identifying highly compensated employees (HCEs) for nondiscrimination purposes. (For 2024 nondiscrimination testing, the prior-year compensation threshold for determining HCE status will be $150,000.) Not only are the dollar thresholds different, but the compensation used for the two determinations and associated lookback periods may also differ. High-earner status for Roth catch-ups is based on FICA wages for the prior calendar year, whereas HCE status is determined using Internal Revenue Code (IRC) Section 415 compensation for the prior plan year. This means plans will have to track HCEs separately from the high earners restricted to Roth catch-up contributions.
  • Other employees must have Roth catch-up option. SECURE 2.0 requires plans to offer Roth catch-up contributions to eligible employees who aren’t high earners if at least one employee is subject to the Roth catch-up mandate for a plan year. This requirement appears to apply even if the high-earning employee doesn’t actually make any catch-up contributions for the plan year. The provision effectively means that most DC plans permitting catch-up contributions will need to offer a Roth feature to all participants.
  • Election requirement. The act suggests that high-earning employees might need to elect to have catch-up contributions made on a Roth basis. Treasury can also issue regulations allowing a change to an employee’s catch-up election for a plan year if the plan later determines that the employee’s prior-year wages exceeded the compensation threshold. Accordingly, plans may need to modify their existing practices for catch-up elections. For example, some plans don’t require employees to make a separate catch-up election but simply treat contributions exceeding the applicable deferral limit as catch-up contributions. This approach presumably should still work if a high earner chooses to make all contributions during the year on a Roth basis. However, if a high-earning employee elects pretax deferrals for noncatch-up contributions, the plan may need to obtain a separate Roth election for catch-up contributions.

Need for regulatory guidance. IRS will need to issue guidance on a number of issues before sponsors can implement the Roth catch-up mandate.

  • Employers with multiple DC plans. As noted above, SECURE 2.0 provides that nonhigh earners must have the option to elect Roth catch-ups if at least one catch-up eligible high earner participates in the plan during the year. Under what’s sometimes referred to as a “universal availability” requirement in the tax code and IRS regulations, if an employer wants to offer catch-up contributions under a plan, the employer and all members of the employer’s controlled group must provide the same effective opportunity to make catch-up contributions under all plans in the controlled group (although certain exceptions apply — e.g., for collectively bargained employees). These rules appear to mean that if any plan in a controlled group has a catch-up-eligible high earner participating, all plans in the controlled group must offer the option to make Roth catch-up contributions — even plans that have no participating high earners.
  • Transfers within a controlled group. Guidance is needed on how the Roth catch-up mandate applies to an employee who transfers to another employer in the same controlled group. The annual catch-up contribution limit for an employee applies to all plans in the employer’s controlled group. However, SECURE 2.0 says the Roth catch-up mandate applies to an employee whose prior-year wages with the employer sponsoring the plan exceeded the applicable dollar limit. If a high earner transfers within a controlled group during the year, must the post-transfer employer account for the employee’s prior-year wages with the pretransfer employer for purposes of the Roth catch-up mandate? Does the answer depend on whether the two employers sponsor the same plan or different plans? If status as a high earner follows an employee who transfers within a controlled group under any circumstances, related employers and their recordkeepers will need to work together to track these employees.
  • Indexing the compensation threshold. SECURE 2.0 says the $145,000 limit must be indexed starting in 2025. But does this mean that the 2025 indexed limit will determine which employees are high earners in 2025 (based on 2024 wages) or in 2026 (based on 2025 wages)? HCE determinations are also made using prior-year earnings. When IRS adjusts that dollar threshold, the adjusted amount applies to the lookback year. For example, the 2023 HCE compensation threshold is $150,000, which means employees who make more than this amount in the 2023 plan year will be HCEs for 2024 nondiscrimination testing. If the indexed high-earner threshold works in the same way, the first indexed amount will apply for the 2025 lookback year (i.e., for purposes of catch-up contributions made in 2026), meaning that the $145,000 limit will apply for both 2024 and 2025 high-earner determinations. IRS guidance is needed.
  • Correcting administrative errors. Plan administrators will need guidance on correcting errors. For example, an employer might fail to treat an employee as a high earner and allow the employee to make catch-up contributions on a pretax basis. Ordinarily, when a plan fails to honor an employee’s Roth election and treats the employee’s contribution as a pretax deferral, IRS guidance says the plan can correct the error by transferring the contribution plus earnings to the employee’s Roth account. The employer then must either issue the employee a corrected Form W-2 for the tax year in which the error occurred or include the amount transferred to the Roth account in the employee’s compensation in the year of the transfer. This same correction method presumably could apply to a high earner’s catch-up contributions that should have been made on a Roth basis, even if the employee didn’t make a Roth catch-up election.
  • Correcting ADP testing failures. IRS will need to advise employers on how — or whether — a high earner’s pretax contributions can be treated as Roth catch-up contributions to correct a failed actual deferral percentage (ADP) test. Current IRS regulations allow a plan to treat a catch-up eligible HCE’s excess deferrals as catch-up contributions to the extent the HCE hasn’t reached the catch-up limit. But ADP testing failures usually aren’t discovered until after the end of the plan year in which the deferrals were made. The Roth catch-up mandate raises questions for plans with catch-up eligible HCEs who have excess pretax deferrals. Could a plan in this situation follow the IRS guidance (discussed above) by transferring the excess deferrals to the HCE’s Roth account and treating them as catch-up contributions? Would this depend on whether the HCE has a Roth catch-up election in effect?
  • Special catch-up contributions under 403(b) and 457(b) plans. Certain 403(b) and 457(b) plans can allow additional catch-up contributions above the limit that ordinarily applies. SECURE 2.0 is unclear, but the Roth catch-up mandate doesn’t appear to apply to these special catch-up contributions.

Need for technical corrections. The provision contains a drafting error that inadvertently eliminates all catch-up contributions starting in 2024. Congress is aware of this error and is consulting with Treasury on technical corrections legislation. Treasury officials have informally indicated that the agency will enforce the catch-up rules as intended for 2024, pending technical corrections to the statute.

Addressing administrative complexity. The Roth catch-up mandate will significantly complicate the administration of catch-up contributions, so employers may be looking for ways to minimize the additional burdens. But employers should proceed with caution. For example, an employer might want to eliminate catch-up contributions for high earners to avoid having mandatory Roth catch-up contributions for only some employees. However, such a change would appear to violate the universal availability rule discussed above. Alternatively, an employer might want to consider mandating Roth catch-ups for all employees, but neither SECURE 2.0’s statutory language nor the Roth rules suggest that this is allowed. In the absence of IRS guidance allowing these design changes, the only alternative would be for a plan to eliminate catch-up contributions altogether, which may be unpopular with employees.

Roth employer match and nonelective contributions

Under prior law, employees could designate only their own deferrals as Roth contributions. Starting Dec. 30, 2022, SECURE 2.0 allows participants in 401(k), 403(b) and governmental 457(b) plans with a Roth feature to designate employer matching contributions (including matching contributions on qualified student loan repayments) and nonelective contributions as Roth contributions. Adopting this provision appears to be voluntary for employers, since plans don’t have to offer a Roth feature. However, the statute isn’t entirely clear on whether a plan with a Roth deferral feature must also offer the Roth option on matching and nonelective contributions. IRS confirmation would be helpful.

  • Not excludable from employees’ gross income. Roth matching and nonelective contributions are taxable when made. However, the act doesn’t specify how or when these amounts should be reported for income tax purposes (e.g., whether they are W-2 wages or instead reportable on Form 1099-R). The law also doesn’t say whether these amounts are subject to FICA, the Federal Unemployment Tax Act (FUTA) and income tax withholding. (Currently, matching and nonelective contributions made on a pretax basis are exempt from FICA and FUTA taxes.) IRS guidance is needed to resolve these questions and to confirm whether these contributions are includable in employees’ income in the tax year the contributions are made, even if they relate to a prior tax year.
  • Must be nonforfeitable. Roth matching and nonelective contributions must be nonforfeitable. The statute is silent on whether sponsors can require employees to meet the plan’s vesting requirements before receiving Roth matching or nonelective contributions. Would such a requirement effectively impose an eligibility condition for Roth matching or nonelective contributions? If so, would the plan violate the tax code’s minimum age and service requirements if the vesting period exceeded two years (which is the maximum service requirement DC plans can impose for eligibility for these types of plan benefits)? Or could plans with graded vesting schedules allow partially vested employees to receive only the vested portion of these contributions on a Roth basis?
  • Participant election required. The act doesn’t explain how employees will elect to receive Roth matching or nonelective contributions, including whether sponsors can allow partial elections or designate Roth as the default. The statute isn’t entirely clear but appears to allow an employee to designate matching and nonelective contributions as Roth, even if the employee’s deferrals aren’t made on a Roth basis.
  • Application of qualified distribution rules. If an employee elects to receive Roth matching and nonelective contributions, distributions of these amounts will have to conform to the qualified distribution rules (discussed above) for the employee to receive full Roth tax benefits. For example, profit-sharing plans can generally distribute contributions not attributable to elective deferrals after two years. However, for profit-sharing contributions made on a Roth basis, such a distribution may not be qualified and could result in the participant facing additional tax liability on earnings that would otherwise be tax-free if the distribution were qualified. Sponsors that decide to offer this option will need to update their summary plan descriptions and other plan-related communications to inform participants about the differing distribution rules for regular versus Roth matching and nonelective contributions.

Other Roth provisions in SECURE 2.0

Other provisions of the act eliminate predeath RMDs from DC plan Roth accounts, introduce Roth-based emergency savings accounts within DC plans, and expand Roth features to SEP and SIMPLE plans.

No RMDs for DC Roth accounts before employee’s death

DC plan participants will no longer have to take RMDs from their Roth accounts before death. This treatment aligns the RMD rules for in-plan Roth accounts with Roth IRAs. The change applies to taxable years beginning after 2023, but plans must still pay RMDs relating to earlier tax years. For example, plans must still pay 2023 RMDs to participants whose required beginning date is April 1, 2024.

Pension-linked emergency savings accounts

SECURE 2.0 lets sponsors offer in-plan emergency savings accounts to nonhighly compensated employees for plan years starting after Dec. 31, 2023.

  • Employee contributions on Roth basis. Employee contributions to these accounts will have to be made on a Roth basis (employer contributions aren’t permitted). The act says these accounts will be treated as designated Roth accounts. Once the balance attributable to employee contributions reaches $2,500 (indexed after 2024), contributions to the account must cease until the balance drops back below the cap. The act allows sponsors to treat excess emergency savings contributions as contributions to the participant’s designated Roth account in the plan (if the employee has one). Employers must treat emergency savings contributions as elective deferrals for purposes of the plan’s matching contribution (if any).
  • Withdrawals treated as qualified distributions. Participants must be able to withdraw all or part of their savings account balance without penalty at least monthly and at no cost up to four times a year, subject to reasonable restrictions. The statute provides that distributions from the account are automatically treated as qualified distributions. On termination of employment or discontinuation of the savings account feature, employees can elect to transfer all or part of the remaining balance as an eligible rollover distribution into their designated Roth account in the plan.

A full discussion of these accounts is beyond the scope of this article.

Roth contributions for SEPs and SIMPLE IRAs

Under a SEP, an employer establishes IRAs for its employees and contributes a uniform percentage of compensation to employees’ accounts. Employees can’t elect to defer compensation from the employer to the SEP (except for salary-reduction SEPs (SARSEPs) established before 1997), but employees can make their own SEP contributions, subject to the regular IRA rules. A SIMPLE IRA is a plan established by certain small employers under which employees can elect to defer compensation from the employer, and the employer must make either matching or nonelective contributions.

Prior to SECURE 2.0, contributions to SEPs and SIMPLE IRAs had to be made on a pretax basis. Starting in 2023, SEPs and SIMPLE IRAs can accept Roth contributions.

  • Employee election required. Employees must make an election to have their SEP or SIMPLE IRA treated as a Roth account. The act directs Treasury to issue guidance establishing the timing and manner of that election.
  • Roth contributions aren’t excludable. As with the Roth matching and nonelective contributions discussed above, the act doesn’t specify how to treat employer Roth contributions to SEPs and SIMPLE IRAs for purposes of tax withholding and reporting.
  • Contributions count toward Roth IRA limits. All SEP and SIMPLE IRA contributions — including pretax contributions — apparently count toward a covered employee’s Roth IRA contribution limit, starting in 2023. This change appears to be an unintentional drafting error that technical corrections legislation could address.

The statute isn’t clear whether employers must offer a Roth option in SEPs and SIMPLE IRAs. Agency clarification would be helpful.

Plan amendments

The plan amendment deadline for SECURE 2.0 provisions is the end of the first plan year beginning on or after Jan. 1, 2025 (2027 for governmental and collectively bargained plans). This deadline applies to sponsors that implement any of SECURE 2.0’s Roth provisions before that date. For sponsors that first offer any of the Roth provisions after the amendment deadline, the usual discretionary amendment timing rule will apply (i.e., amendments will be due by the end of the plan year in which the sponsor first offers the option).

Biden plan to limit Roth conversions

Notwithstanding the SECURE 2.0 Act’s encouragement of more Roth treatment for retirement savings, the Biden administration is seeking new restrictions on conversions and rollovers to Roth accounts and Roth IRAs. The proposals, included in the president’s FY 2024 budget request to Congress, are substantially similar to provisions that cleared the House during the last Congress in a Democrat-authored budget package but got dropped before final passage of a scaled-down measure, the Inflation Reduction Act (Pub. L. No. 117-169).

The president’s budget plan calls for banning Roth conversions of after-tax contributions in employer retirement plans, imposing a $10 million cap on combined DC plan and individual retirement account (IRA) balances for high earners (individuals earning at least $400,000–$450,000), and prohibiting all Roth conversions for these high-income taxpayers. The proposals have little chance of being enacted in this Congress under a Republican-controlled House and would face obstacles even if Democrats still ran both chambers.

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