SECURE 2.0’s Roth Catch-Up Mandate: The Devilish Details

The IRS has offered a generous two-year delay for the SECURE Act 2.0’s mandate that all catch-up contributions for certain high-income taxpayers must be treated as Roth contributions. Still, many plan sponsors and participants have been wondering about the nitty-gritty details that will determine how the actual rule is implemented in practice. In the same guidance that delayed the formal effective date of the Roth catch-up mandate, the IRS offered important answers to some pressing questions—and acknowledged that additional questions do remain to be answered in forthcoming guidance.

SECURE 2.0 & Catch-Up Contributions: Background

For company-sponsored retirement plans (including 401(k)s and 403(b) plans), the catch-up contribution limit is $7,500 in 2023. 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. The $10,000 limit will also be indexed for inflation. Once the taxpayer reaches age 64, the regular (lower) catch-up contribution limit applies.

Starting in 2026 (after the two-year delay offered by the IRS), if a taxpayer has income of at least $145,000 for the prior year, the catch-up contribution for the subsequent year must be treated as a Roth contribution. That means these funds are contributed with after-tax dollars, so they will not reduce current taxable income, but can be withdrawn tax-free in the future.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.

The $145,000 threshold is a new threshold and is not tied to existing definitions of highly compensated employee. The $145,000 amount is also tied to W income (because the SECURE Act 2.0 provision governing these new rules references an IRC Section related to W compensation). Therefore, if an S corporation owner only takes $130,000 in “compensation” but also receives additional profits from the S corporation, the owner will not have crossed the $145,000 threshold to trigger the Roth contribution rule.

Similarly, many expected that the new Roth contribution rule would not apply for sole proprietors, partners in partnerships, or LLC members who are taxed as sole proprietors. That’s because these taxpayers are considered self-employed and, by definition, do not receive W compensation.

IRS Guidance on the Roth Catch-Up Mandate

First and foremost, in Notice 2023-62, the IRS delayed the effective date of the new Roth catch-up rule to 2026. The IRS also confirmed that the definition of “wages” for purposes of the Roth mandate includes only wages that are subject to FICA taxes (so amounts that are reported in Box 3 of the taxpayer’s Form W).

The IRS clarified that if an employee who is subject to the Roth catch-up requirement elects to make catch-up contributions on a pre-tax basis, the plan sponsor can disregard that election and treat the catch-up as a Roth contribution.

When multiple employers sponsor the same 401(k) and an employee has wages from more than one of those employers, the amounts will not be aggregated for purposes of determining whether the employee is subject to the Roth mandate.

Of course, not all answers were so easy for the IRS to address. The IRS has requested comments on whether employers should be required to either offer a Roth option or eliminate catch-up contributions altogether (in other words, whether an employer should be permitted to not offer a Roth option and limit catch-up contributions only to lower-paid employees who are eligible to make pre-tax catch-up contributions). Under current law, offering a Roth contribution option is entirely optional for employer-sponsored retirement plans.

Conclusion

The Roth catch-up contribution requirement is much more complex than it appears on the surface. It is expected that additional guidance and clarification will be forthcoming before the mandate formally becomes effective. Of course, plan sponsors and participants should pay close attention and start planning now to be ready for the future changes.

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