The Internal Revenue Service has released long-awaited proposed regulations that clarify the retirement plan contribution provisions enacted by the Secure 2.0 Act. Of particular note are the new rules governing mandatory Roth catch-up contributions for higher-income employees.
The new proposed regulations are deemed to apply for contributions in tax years that begin six months after the final regulations are published. Plans can, however, elect to apply the proposed regulations now.
While the regulations do offer clarifications, they also leave some questions unanswered. This demonstrates how all business owners should pay close attention to the details and watch for continuing guidance as they implement their retirement savings options.
Catch-Up Contribution Changes: Background
Starting in 2026, for taxpayers with income of at least $145,000 in the prior year from the employer sponsoring the plan, the catch-up contribution must be treated as a Roth contribution. Originally, the requirement was set to become effective in 2024, but the IRS delayed the effective date until 2026.
That means that these funds are contributed with after-tax dollars, so they will not reduce current taxable income but can be withdrawn tax-free in the future. The $145,000 amount will also be indexed for inflation in future years.
Starting in 2025, a new special catch-up contribution is permitted for taxpayers who are between ages 60 and 63. That contribution limit will be equal to the greater of (1) $10,000 or (2) 150% of the standard catch-up contribution limit for 2024.
Roth Guidance in the Proposed Regulations
The IRS confirmed that it remains optional for employers to offer a Roth savings option. If the plan itself does not offer a Roth savings option, an individual subject to the Roth catch-up requirement will not be permitted to make catch-up contributions at all. Employers, then, must track which employees are subject to the catch-up rule regardless of their choice.
However, pursuant to the proposed regulations, if employees subject to the Roth catch-up requirement are permitted to make Roth catch-up contributions, all catch-up eligible employees must be permitted to make Roth catch-up contributions.
The IRS also clarified that only FICA wages from the employer are counted in determining whether the employee is subject to the Roth catch-up requirement; self-employment income is not counted. Similarly, if employees had no FICA wages from the employer in the prior year, they are not subject to the Roth catch-up requirement even if their wages in the current year exceed the threshold.
The wage threshold is not prorated for an employee’s first year of employment, so the employee’s FICA wages must have exceeded the full threshold for the prior year to become subject to the Roth catch-up requirement.
The applicable FICA wages must come from the individual’s common law employer. When multiple employers sponsor the plan, wages from one employer are not aggregated with the wages from another employer sponsoring the plan.
Employees subject to the Roth catch-up requirement will not be required to make an affirmative election to have their catch-up contributions treated as Roth contributions. Contributions from employees who have made elections to defer on a pre-tax basis will automatically be treated as Roth catch-up contributions if the employee is subject to the requirement and the employer has adopted the deemed election rule.
Pursuant to the deemed election rule, however, the employee must be given an opportunity to stop making catch-up contributions altogether.
The regulations also confirm that 403(b) plans will not violate the universal availability rule by allowing individuals subject to the Roth catch-up requirement to make those Roth contributions.
Correcting Errors
The proposed regulations have also provided new methods to correct failures to adhere to the Roth catch-up requirements. The W-2 method allows the employer to transfer the catch-up contribution from the traditional 401(k) to the Roth account and report the contributions on the employee’s W-2. Employers can also use a direct rollover between the traditional and Roth accounts within the plan and report the contribution on Form 1099-R.
The employer must apply the same correction method to all plan participants for the plan year in question.
To use these methods, however, the employer must have adopted effective procedures to comply with the Roth catch-up requirement. Specifically, the employer must have adopted the deemed Roth catch-up election provision.
Regulations Affecting the Enhanced Catch-Up Limits
With respect to the enhanced catch-up contribution limits, the proposed regulations confirm that plans do not violate the universal availability requirements simply by allowing participants between ages 60 and 63 to make the increased catch-up contributions.
The proposed regulations also confirm that the enhanced catch-up contribution option is entirely optional for employers. Employers can elect to subject all employees to the typical catch-up contribution limits.
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