IRS Delays Secure 2.0 Roth Catch-Up Change for Retirement Plans

To Roth or not? I get asked some version of this question daily. Thanks to the passage of SECURE Act 2.0 (“The Act”), certain highly paid individuals are now mandated to make age-50 catch-up contributions on a Roth basis. In short, Congress created a revenue raiser by requiring certain highly paid retirement plan participants to make catch-up contributions on a Roth basis. 

Section 603 of the Act mandates that age-50 catch-up contributions for higher-paid retirement plan participants be made on a Roth basis. Specifically, this provision requires catch-up contributions, by those participants with more than $145,000 (adjusted for inflation) in wages (defined as IRC Section 3121(a)) from the employer sponsoring the plan in the prior year, be made on a Roth basis beginning January 1, 2024, thus eliminating the option to make pre-tax catch-up contributions. This rule applies to catch-up contributions for 401(k), 403(b), and governmental 457(b) plans. Notably, it does not affect catch-up contributions for IRAs (including SIMPLE IRAs).

Under a plan that offers age-50 catch-up contributions (it’s optional) and has high-income participants (those with wages greater than $145,000), those high earners are required to make catch-up contributions on a Roth basis. However, participants that make less than $145,000 would continue to have the option to make catch-up contributions on a pre-tax or after-tax Roth basis. Notably, for a plan that does not allow participants to make catch-up contributions to a Roth account, catch-up contribution rules will not apply to that plan (both those with wages above and below the $145,000 threshold). In other words, if a plan has affected participants and doesn’t offer a Roth catch-up option, then no one (regardless of their prior year’s income) would be allowed to make catch-up contributions.

This provision, at first glance, seems straightforward. Unfortunately, a strict reading of the text left industry professionals looking for clarity. The are several unexpected quirks that have prevented implementation by affected plans, even though it’s mandated by the Act. Adding to the urgency, the provision is effective for plan years beginning after December 31, 2023 (January 1, 2024). Enter the IRS.

On August 23, the IRS issued Notice 2023-62 affording affected plans a two-year administrative transition period to facilitate compliance through December 31, 2025. During this transition period, plans may continue to allow pre-tax catch-up contributions by affected participants, and plans that do not offer a Roth feature may continue to allow catch-up contributions. In other words, IRS guidance grants a two-year delay in the provision's effective date that mandates that catch-up contributions must be made on a Roth basis for those participants earning more than $145,000 (different definition used to determine Highly Compensated Employee¹ status). Specifically, until taxable years beginning after December 31, 2025, those catch-up contributions will be treated as satisfying requirements of Section 603 of the Act, even if contributions are not designated Roth contributions, and a plan that does not offer designated Roth contributions will be treated as being compliant. The American Retirement Association (ARA) had asked for relief. As ARA chief executive officer Brian Graff said, “We appreciate the Treasury Department and the IRS understanding how challenging it would have been to comply with mandatory Roth catch-up requirements by January 1, 2024. Allowing for a two-year transition period is a big win for plan sponsors, recordkeepers, and participants."

 

Section 603 of the Act was scheduled to take effect January 1, 2024. Conformity with the mandatory Roth catch-up provision has proved to be loaded with complexity. To name just two examples, systems needed to be programmed (tracking the $145,000 threshold), and new processes and participant education implemented. There were also several open questions regarding the mandatory Roth catch-up provision. Notice 2023-62 provides relief to affected parties, giving providers needed time to hash out these issues.

IRS Notice 2023-62 provides the following:

• Catch-up contributions made by affected participants will be treated as compliant, even if they are not made on a Roth basis.
• Plans that do not currently offer a Roth contribution option will be treated as compliant, without the need to currently add a Roth option.
• Secure Act 2.0 contains a drafting error whereby Congress erroneously eliminated all catch-up contributions (pre-tax or Roth) entirely, beginning in 2024. Congress previously notified the IRS that it intends to fix this error. The Notice provides reliance on that intention, permitting plans to continue to operate as if catch-ups were still included in the Internal Revenue Code. Catch-up contributions can continue to be made after 2023. 

To assist with mandatory Roth catch-up implementation, the IRS signaled its intent to issue future guidance on issues that have been raised by practitioners. Here are several outstanding items that require further guidance.

• Are plans with affected participants required to offer a Roth deferral option? While common, 401(k) plans are not required to offer participants a Roth option. Can these plans comply with Section 603 by not offering highly paid participants the option to make catch-up contributions? A second key question: What happens when participants who are required to make Roth catch-up contributions (previous-year wages exceed $145,000) are unable to do so because their plans don’t offer a Roth option?
  
• Self-employed participants. How does the provision affect individuals who do not have IRC Section 3121(a) wages in the prior year from the employer sponsoring the plan? As written, the limit would only apply to individuals with FICA wages above $145,000. Therefore, individuals who don’t have FICA wages, such as self-employed individuals and certain government employees not eligible for Social Security benefits, wouldn’t be subject to this rule. If the limit applies only to those with FICA wages greater than $145,000, it appears that those who do not earn FICA wages are exempt from the (Roth catch-up) requirement, regardless of income. The IRS needs to weigh in here.
  

IRS Notice 2023-62 serves as good news to plan sponsors and industry professionals. It offers plan sponsors a two-year transition period during which a plan will be treated as being compliant with Section 603 of Secure Act 2.0, even if a plan permits affected participants to make pre-tax catch-up contributions and continues not to make Roth deferrals available to any participants. "The IRS basically has announced that they will interpret around the legislative text glitch that's been discussed,” said Kelsey Mayo, Outside Director of Regulatory Affairs for the ARA. “They're essentially saying catch-up provisions have not been eliminated, period. That’s point number one. And point number two—now you don't have to make it a Roth for two years, and it can continue to be pre-tax catch-ups until 2026 regardless of income.”