Plan sponsors and recordkeepers breathed a sigh of relief when the start date for complying with SECURE 2.0’s Roth catch-up contribution requirement was delayed until 2026. They were relieved because it was foreseeable from the beginning that compliance with this requirement would introduce unwelcome complexity to 401(k) and 403(b) plan administration.
There were many reasons complex changes were to be expected. First, the requirement applies only to employees (but not partners) who earned over $145,000 (indexed) in the prior year. $145,000 is not a number required to be tracked by plans for any other purpose and a minority of plans don’t currently provide for Roth contributions at all. There were also a number of open questions about how the requirement worked for employees in controlled groups or covered under multiple employer plans. Finally, plan sponsors were concerned about the consequences of inadvertent violations due to mistakes in reporting compensation and needed to know how violations could be corrected.
Proposed Regulations Set Out Decision Items. The statutory provision has not been amended or repealed and 2026 is not so far away (though the IRS is providing additional time for multiemployer plans.) The IRS provided some guidance in proposed regulations issued at the beginning of this year with special rules that seemed to increase the complexity of complying with the Roth catch-up requirement. Dealing with this complexity requires advance planning and advance decisions. Here are some issues that plan sponsors should be looking at now:
· Do you need to add a Roth feature to your plan? Otherwise, affected employees will not be able to make any catch-up contributions and you will still need to track which participants are subject to the Roth requirement in order to exclude them. Just to make things more difficult, the IRS has said that plans may not require all employees to make Roth catch-up contributions, which would eliminate the need to track eligibility, and they also cannot limit Roth contributions to those covered by the new requirement. Recordkeepers will require lead time to implement any amendment adding a Roth feature to a plan.
· Will you have deemed Roth elections? Plans do not have to require that affected participants make an affirmative Roth election for catch-up or all contributions. The regulations permit but do not require plans to have a deemed Roth election for affected participants that will automatically convert additional deferrals to Roth contributions once a participant has made the maximum regular deferrals. A plan may provide for a deemed Roth catch-up election without regard to whether it requires separate elections for elective deferrals that are not catch-up contributions and for additional elective deferrals that are catch-up contributions or uses a spillover design. Plans that use the deemed election will be able to use special correction procedures including automatically converting any pre-tax deferrals made in excess of the regular limit to Roth deferrals. However, participants must have an opportunity to opt out of the deemed election, for example by discontinuing additional contributions.
· How will you track wages? Systems need to be set up to separately track the compensation taken into account for the Roth catch-up requirement, and this may be challenging for businesses using a common paymaster. There are several traps for the unwary arising from the special rules in the regulations that any compliance system must reflect.
· New Hires. Since the wage determination looks to the prior year, new employees will not be subject to the Roth requirement in their year of hire.
· No proration. While the Section 401(a)(17) compensation limit is pro-rated for short plan years, annual compensation for purposes of the catch-up contribution requirement is not pro-rated if an employee was employed for fewer than 12 months.
· Controlled Group Members. While compensation from all controlled group members is aggregated for purposes of determining compliance with the Section 401(a)(17) compensation limit and the Section 415 limit, compensation from all members of a controlled group will not be aggregated in determining who is subject to the Roth catch-up requirement. Only wages from a participant’s common law employer that participates in the plan are counted, and this can lead to counterintuitive results. For example, If Subsidiary A has a plan but Subsidiary B does not, only wages from Subsidiary A would be counted.
· Multiple Employer Plans. A similar rule applies to employees who work for more than one participating employer in a multiple employer plan (MEP) even though compensation and service from all participating MEP employers are usually aggregated. If an employee worked for companies A and B in the prior year, both A and B were contributing to a MEP and the employee earned $80,000 from A and $100,000 from B, that employee would not be subject to the Roth catch-up requirement even though th employee’ total compensation from participating employers exceeded $145,000.
· How will you exclude self-employed individuals (owners and partners)? Self-employed individuals are not subject to the new requirement because it tracks FICA wages only and not earnings from self-employment. Systems will need to track events such as a law firm associate becoming a partner.
· New Correction Methods. Plans with compliance procedures electing to use deemed elections have two correction methods that do not involve refunding contributions. These are converting pre-tax deferrals that shouldn’t have been allowed to Roth deferrals if the error is caught before W-2s are filed and sent out and doing an in-plan Roth rollover reportable on Form 1099R.
· Consider Adding an EACA. Plans with automatic enrollment that permit participants to opt out of participation within up to 90 days of automatic enrollment (EACAs) have more time to make corrections. Plans adopted after December 29, 2022 are required to have EACAs, but other plans with automatic enrollment do not have EACAS and might consider adding the withdrawal feature to facilitate corrections.
· How will your payroll provider coordinate with your recordkeeper? The payroll feed will require changes to provide the information the recordkeeper needs, and they may need to communicate about format and necessary changes.
· Will this affect your nonqualified plan? The 409A rules permit nonqualified 401(k) arrangements where contributions spill over to the nonqualified plan after certain qualified plan limits are reached. While not addressed in the regulations, these arrangements should be reviewed for any necessary changes and compliance issues.
It’s clear that these decisions can’t be put off until December. The earlier they are addressed, the smoother the compliance process will be.