Author: Steven Grieb
On August 25, 2023, the IRS issued Notice 2023-62, which provides limited guidance regarding the SECURE 2.0 Act of 2022 (SECURE 2.0) rule requiring some participants to contribute catch-up contributions on a Roth only basis. Although the Notice leaves many outstanding questions relating to this new SECURE 2.0 rule, it provides relief by giving a "two-year administrative transition period," effectively moving back the date by which plan sponsors must comply.
SECURE 2.0 catch-up Roth rule
Under SECURE 2.0, any 401(k) plan, 403(b) plan or governmental 457(b) plan that permits participants to make catch-up contributions must require such contributions to be designated Roth contributions, starting in 2024 (the "catch-up Roth rule"). This restriction will only apply to participants whose compensation during the prior year exceeds $145,000 (as adjusted annually for inflation). Participants who earned $145,000 or less in the prior year can still defer catch-up contributions on a pre-tax basis. Participants who are over age 50 and earn more than $145,000 may not elect to make their catch-up contributions on a pre-tax basis. The catch-up Roth rule wouldn't apply to SIMPLE IRA plans or SEP plans.
As the 2024 deadline for the catch-up Roth rule has approached, many in the retirement plan industry became concerned about the ability of plan sponsors to properly apply the rule on a timely basis. Plans will require guidance on numerous issues. From an administrative standpoint, questions arose about who bears responsibility for making certain that the rule is properly implemented. Consequently, several groups representing the interest of retirement plans have asked for a delay in the catch-up Roth rule's implementation.
Correcting a technical glitch
Before turning to the effective date for the catch-up Roth rule, the Notice addresses a technical error in SECURE 2.0. Specifically, SECURE 2.0 strikes certain language from the Internal Revenue Code that, if read strictly, would prohibit any participant from making catch-up contributions (pre-tax or Roth), starting in 2024. Congress didn't intend to eliminate the Code language that allows for catch-up contributions, and many retirement plan professionals questioned whether the IRS has the authority to continue allowing catch-up contributions without new legislation.
Nevertheless, the Notice indicates that the IRS won't treat plan sponsors as having violated the Code solely because they continue to permit catch-up contributions in 2024. This guidance effectively amounts to the IRS turning a blind eye to the technical error in SECURE 2.0. Hopefully, Congress will eventually pass a bill listing corrections under SECURE 2.0, and add the errantly struck language back into the Code.
Effective date extension
The IRS doesn't have the authority to change the effective date of the catch-up Roth rule, which was written into the text of SECURE 2.0. Instead, the Notice states that the IRS will treat 2024 and 2025 as "an administrative transition period" with respect to the catch-up Roth rule. Specifically, the IRS will allow participants who made more than $145,000 in the preceding year to make their catch-up contributions on a pre-tax basis, if they so choose. Also, plans that don't offer Roth contributions can continue to allow participants to make catch-up contributions.
This administrative transition period comes as a relief to plan sponsors, as well as record-keepers and payroll providers. The delay gives plan sponsors the opportunity to sort through how the catch-up Roth rule will be implemented, as well as allowing the IRS time to provide needed guidance on a host of questions.
Additional guidance coming
Finally, the Notice states that the IRS intends to issue further guidance on this matter and gives several examples of the issues they'll address. The Notice doesn't give any specific time as to when the additional guidance will be provided. First, the IRS will issue direction relating to the definition of compensation for purposes of determining who has earned more than $145,000. Specifically, SECURE 2.0 uses the FICA tax definition of compensation in running that calculation. Under that standard, the Notice indicates that partners or other self-employed individuals wouldn't be subject to the catch-up Roth rule because they have no FICA compensation. The same conclusion would apply to state or local government employees who have no FICA compensation.
Additionally, future guidance will address the plan's authority with respect to employees who have elected to make pre-tax deferrals into the plan. If the participant is subject to the catch-up Roth rule, the future guidance will specify that once the participant reaches the 402(g) limit, the plan may continue to take deferrals from the participant's paychecks on a Roth basis, even in the absence of an affirmative election by the participant to make Roth contributions into the plan.
Finally, the upcoming guidance will address which employer's compensation will apply when determining whether an employee has earned more than $145,000 in the prior year. Some commentators have asked whether only compensation earned by the plan sponsor would count toward the $145,000 number, or if all compensation earned from any employer would be included. The notice indicates that only compensation from the plan sponsor's controlled group counts towards the determination. In fact, in a multiple employer plan, compensation paid in the preceding year by one participating employer wouldn't be aggregated with the wages from another participating employer, presuming the two employers weren't in the same controlled group.
The two-year administrative transition period will be a welcome development for plan sponsors and service providers alike. Additionally, the further points discussed by the IRS in the Notice provide some much needed answers regarding the catch-up Roth rule. Still, with supplementary guidance from the IRS yet to come, plan sponsors shouldn't become complacent on this issue. Any plan sponsor that offers catch-up contributions may continue to allow them in 2024. However, retirement plan administrators and service providers should continue to follow this issue with diligence. Your Gallagher consultant will make sure that you always have the most up-to-date developments regarding the catch-up Roth rule and all other SECURE 2.0 changes.