By John Schultze and Barry Salkin
One of the changes made by the SECURE 2.0 Act requires that catch-up contributions made by employees with FICA compensation from an employer sponsoring a 401(k), 403(b) or 457(b) defined contribution plan of at least $145,000 in the prior calendar year, as indexed, be made as after-tax Roth catch-up contributions (section 603). This provision, which was supposed to become effective January 1, 2024, is problematic because the IRS has issued no guidance, and many service providers have stated they will be unable to update their systems by the end of the year.
IRS Notice 2023-62, released on August 25, 2023, provides a two-year transition period that extends the implementation of this new Roth catch-up contribution rule until 2026.
What was the change to catch-up contributions? Currently, a participant who has attained age 50 and satisfied the contribution limits under a plan (the dollar limit or a lower plan-imposed limit) may make catch-up contributions, if the plan permits, on either a pre-tax or post-tax Roth basis as elected by the participant if the plan accepts Roth contributions.
The change made by SECURE 2.0 Act requires that eligible employees with FICA compensation from the employer of $145,000 or more in the prior calendar year, as indexed (an “eligible participant”), who make catch-up contributions must do so as after-tax Roth contributions for taxable years beginning after 2023. Participants with FICA compensation below the dollar threshold can continue to make catch-up contributions on either a pre-tax or Roth basis. Based on the original January 1, 2024, effective date of this change, a plan sponsor would have had to identify its eligible participants during 2023, so their catch-up contributions could be made as Roth contributions in 2024.
In the Notice, the IRS states that plan participants aged 50 and older can continue to make catchup contributions after 2023, regardless of income, on a pre-tax or Roth basis.
The delayed implementation is important for at least three reasons. First, if a plan allows for catch-up contributions but does not accept Roth contributions, absent the IRS Notice, the plan would have to be amended either to accept Roth contributions or to suspend catch-up contributions. Because each of these changes involves a plan design option, not a legal compliance change, the plan amendment would have to be in place by January 1, 2024; it could not be deferred until the extended SECURE 2.0 Act amendment deadline, the last day of the 2025 plan year. Under Notice 2023-62, however, a plan that does not provide for Roth contributions will be treated as satisfying the new requirement until the end of the transition period. At that time, presumably, such a plan will have to be amended to accept Roth contributions or to discontinue catch-up contributions.
Second, many service providers, primarily payroll companies, have stated they will be unable to implement this provision by January 1, 2024. While recordkeepers will likely be able to implement the change, the capability of internal payroll departments and outside payroll providers to timely implement this new requirement is questionable.
Third, the catch-up contribution change has many open questions that will need to be addressed through IRS guidance. The IRS Notice provides preliminary guidance on the following issues:
- The new Roth catch-up contribution rule does not apply to participants who have non-FICA income above the dollar limit, such as a partner or self-employed individual receiving self-employment income.
- An eligible participant will not have to make an affirmative election to make catch-up contributions on a Roth basis; the plan administrator and employer may treat an election to make catch-up contributions on a pre-tax basis as an election to make catch-up contributions on a Roth basis.
- In the case of a plan maintained by more than one employer, an eligible employee’s FICA wages from more than one participating employer are not aggregated or taken into account by another participating employer when determining if the employee is an eligible participant whose catch-up contributions must be made on a Roth basis. For example, an employee may receive wages from two participating employers in the prior year that in the aggregate exceed $145,000, but unless the participant’s wages from one of the participating employers in the prior year exceeds the dollar limit, the participant’s catch-up contributions are not required to be made as Roth contributions. As a corollary, if a participant received more than $145,000 in wages from one participating employer in the prior year, the participant’s catch-up contributions made under a different participating employer are not required to be made as Roth contributions unless the participant’s wages from that employer exceeds the dollar limit.
Additional questions not addressed in the Notice include: What happens if a sponsor incorrectly categorizes a participant due an error in determining wages? How should a sponsor address amounts that are recharacterized as catch-up contributions to correct nondiscrimination testing?
Many of the provisions of the SECURE Act of 2019 and the SECURE 2.0 Act of 2022 are currently effective or will become effective over the next few years, and plans must be operated in compliance with the changes as they become effective. Because so little guidance has been issued at this time, the extension provided under this IRS Notice is welcome and will allow for a more orderly transition to comply with the catch-up contribution change.
We’ll continue to provide information about the changes under the SECURE Acts as they become eﬀective and explain any actions plan sponsors may need to take. If you have any questions or concerns about how the new requirements will affect your plan, please feel free to contact us for assistance.