IRS Delays SECURE 2.0 Roth Requirement for Catch-Up Contributions For High Earners Until 2026
This article describes another step in our country’s laborious task of implementing the SECURE 2.0 Act of 2022, which, together with its predecessor SECURE Act of 2019, is making major changes regarding retirement accounts such as 401(k) plans, Individual Retirement Accounts, and governmental 457(b) plans.
Proposed Treasury regulations issued in February 2022 to implement SECURE (not even SECURE 2.0 yet) differed vastly from what many practitioners expected. Final regulations have yet to be issued. The content of those final regulations is unknown to say the least.
SECURE is rocking the retirement account world. The law in this area is in flux.
The latest installment relates to catch-up contributions by individuals 50 or over who are considered “high earners” in this context.
What is a catch-up contribution?
As you probably know, every year the Internal Revenue Service (“IRS”) sets limits on how much an individual may contribute to his or her retirement account. The limit is different depending on the type of account. Individuals may “max out” their contribution each year by contributing that amount. They may contribute no more for that year after reaching that limit.
But for individuals age 50 or over, Internal Revenue Code Section 414(v) permits a “catch-up contribution”, on top of the annual contribution, to save more towards retirement. When a catch-up contribution is made by an individual age 50 or older, the total contribution will be larger than the standard contribution limit. Every year the IRS sets limits on catch-up contributions as well, by type of account.
How did SECURE 2.0 affect catch-up contributions?
Section 603 of SECURE 2.0 required that, for tax years beginning after December 31, 2023, catch-up contributions made to 401(k), 403(b), and governmental 457(b) plans by employees whose FICA (Federal Insurance Contributions Act) wages in the prior year exceeded $145,000 (as adjusted in future years) must be made as Roth contributions, meaning on a post-tax basis. This requirement in Section 603 of SECURE 2.0 is a change to the current rules which allow the employee to designate whether the catch-up contribution is to be made on a pre-tax or post-tax basis.
Note the above change applies only to individuals 50 or over who are considered “high earners” in this context: FICA wages in prior year exceeding (as adjusted in future years) $145,000.
What’s the problem with requiring these “high earners” to make catch-up contributions on a post-tax basis?
The problem is employers as plan sponsors need to be set up to allow Roth contributions, and not all are. Plus implementation of this regulation is a more complex matter than it may seem, when reconciling it with other aspects of IRC Section 404 concerning both high- and non-high earners.
Factors include: (i) the short timeframe from the passage of SECURE 2.0 on December 29, 2022 to January 1, 2024 (which is the effective date of this designated Roth requirement), and (2) lack of IRS guidance to help employers, plus the third-party administrators who administer the plans, to implement the requirement.
The problem is such that over 200 employer organizations wrote to Congress, the Department of Treasury, and the IRS requesting “transition relief” to allow a more orderly implementation of the requirement.
The IRS answered with a YES. IRS Notice 2023-62 issued on Friday, August 25, 2023, announces a two-year reprieve for employers on the implementation of the Roth catch-up contribution requirement for high earners. The administrative transition period delays the effective date of the requirement to January 1, 2026, and clarifies and confirms other aspects of the regulation.
The Notice also confirms more guidance is to come. The IRS has requested written comments regarding the Notice and any other aspect of Section 603 of SECURE 2.0 by October 24, 2023. In addition, the Notice asks for comments about whether the intended guidance should address a plan that permits eligible participants to make catch-up contributions under Section 414(v) but does not include a qualified Roth contribution program. In particular, should a plan be permitted to prohibit higher-income participants from making catch-up contributions, but allow others to make pre-tax catch-up contributions, or should IRC Section 404(v)(4) continue to require plans to allow all eligible participants to make the same catch-up contribution election?
As a result of this Notice, a plan sponsor now gets 2 years (and a few months) to consider and determine whether to add a Roth contribution feature to its plan (if it does not already have one) and (ii) implement the requirement that a high earner’s catch-up contribution must be made on an after-tax basis.