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FLASHPOINT: No Need to Panic! The IRS Extends Roth Catch-Up Implementation to 2025

FLASHPOINT: No Need to Panic! The IRS Extends Roth Catch-Up Implementation to 2025

By Alison J. Cohen, Esq.

On Friday, August 25, 2023, the Internal Revenue Service (“IRS”) released Notice 2023-62 (the “Notice”), giving plan sponsors long-awaited relief with respect to the implementation of Section 603 of the SECURE 2.0 Act of 2022 (“Section 603”).  Let’s not bury the lede:  the IRS has delayed implementation of Section 603 – the section that mandates that certain catch-up contributions be treated as Roth deferrals – until taxable years beginning after December 31, 2025.

The Notice initiates an Administrative Transition Period lasting until December 31, 2025, during which the provisions of Section 603 are to be treated as if they are not in existence.  This provides a grace period before these rules need to be implemented by both plan sponsors and the IRS, providing time for the development of all the fine points of necessary guidance.

So, What’s in Section 603 for Which Implementation is Being Delayed?

First, there was a technical glitch created in the drafting of Section 603 whereby Congress eliminated Internal Revenue Code (the “Code”) section 402(g)(1)(C).  This was a pretty big “oops,” because it would have eliminated the tax deferral of all catch-up contributions entirely.  Congress already notified the IRS that it intends to fix this error.  The Notice gives us actual reliance on that intention, permitting plans to continue to operate as if Section 402(g)(1)(C) were still on the books.

The second provision of Section 603 was to require that the catch-up contributions made by certain participants be Roth amounts, rather than pre-tax amounts.  In particular, individuals earning more than $145,000 in FICA wages in the prior year (which we will call “higher-paid individuals” or “HPIs” for purposes of this Flashpoint) are required by Section 603 to make any catch-up contributions on a Roth basis.

This provision produced a special conundrum for plans that do not permit Roth deferrals.  If those plan sponsors want to permit catch-up contributions by HPIs, Section 603 also required that the plan be amended, not only to allow these amounts, but must also permit Roth catch-up contributions for everyone.  And, as the rules relating to Roth contributions require those amounts to be available on a nondiscriminatory basis (it is considered to be a “benefit, right, or feature” under Code section 401(a)(4), requiring that it be offered on a nondiscriminatory basis), it is likely that the amendment would need to make the Roth provision broadly available.  In short, if the plan wanted to let HPIs make catch-up contributions, it must simultaneously be amended to permit Roth amounts generally.

Under the Notice’s Administrative Transition Period, a plan may operate through the end of 2025 without implementing the changes to these catch-up contribution provisions.  That means that all participants may continue to make catch-up contributions on a pre-tax basis if they so desire and no amendment to add Roth is required until 2026.

In summary, because Roth contributions are not needed even for HPIs during the Administrative Transition Period, a plan will be treated as complying with Code section 414(v)(7)(B) even if the plan permits HPIs to make pre-tax catch-up contributions and continues not to offer Roth deferrals to anyone.

This Guidance Stops the Current Amendment Panic

This relief comes at a particularly important time, as providers have been struggling to determine if an amendment to add Roth contributions would need to be adopted by January 1, 2024, for calendar year plans to institute them.  The basis of this struggle was determining whether such an amendment was discretionary (in which case it must be made before it is effective, or by January 1, 2024), or if it was “integrally related” to the SECURE changes.  If the latter is the case, the amendment to add Roth need not be added until the SECURE 2.0 extended amended date of the last day of the 2025 plan year, even if it is effective before that time.  With the 2024 year fast approaching and the need to plan not just for one client but perhaps for many, practitioners were becoming concerned that the amendment to add Roth needed to be authorized in the next few weeks for the documents to be timely prepared and signed by year end.

The relief of the Notice means that this issue (and the need to amend to stay qualified) is kicked down the road. If Roth does not need to be implemented until 2026 in relation to catch-up contributions by HPIs, the amendment can be delayed until then, as well.  If you were running around trying to get the Roth amendments off the ground before year end, you can take a deep breath and cease those efforts.  You’ve got time.  Huzzah!

(Of course, if a plan sponsor is going ahead and implementing Roth in 2024, it will need to amend the plan … and, since there is nothing compelling the addition of Roth for plan qualification purposes, it is likely a discretionary amendment and is required to be adopted before the provision becomes effective.)

So, What Will Happen Next on This Issue?

The IRS did clarify its intent at some nebulous future date to release further guidance on the relevant open issues, including:

1) How does Section 603 apply to self-employed individuals or governmental employees who are not paid FICA wages?  If the limit applies only to those with FICA wages in excess of $145,000, it appears that those who do not earn FICA wages are exempt from the requirement, regardless of income.

2) Can plan administrators automatically interpret a catch-up election by a HPI as an implicit Roth election if deferrals are high enough to become catch-up contributions (or if deferrals by HPIs are converted to catch-up contributions due to a failed ADP test)?

3) How should the $145,000 compensation limit be applied under such arrangements as multiple employer and pooled employer plans?  Do we aggregate compensation earned under unrelated participating employers to determine whether the participant has been paid more than $145,000 in the prior year?  The Notice indicates that the IRS is leaning toward treating compensation paid by each employer separately if the companies are unrelated.  So, if an employee earns $100,000 from one employer in a multiple employer plan and then earns $50,000 from another participating employer, this will not be considered to exceed the $145,000 limit for purposes of applying the catch-up rules.

A Bit of History for the “Youts” in the Audience (My Cousin Vinny lives!)

To frame everything discussed above, it’s important to understand some of the special requirements that apply to catch-up contributions and the history of catch-up contributions.  These issues are what makes Section 603 and its implementation so complex.

When catch-up contributions were first created by Congress as part of the Economic Growth Tax Relief and Reconciliation Act of 2001 (“EGTRRA”), many questions arose about what language we needed to come up with for the good-faith amendment, how would catch-up contributions work on payroll reports, did a highly compensated employee need to elect a catch-up deferral to correct a failed ADP test, etc.  For many of our younger readers, the fact that this was confusing and contentious probably seems preposterous, because catch-up contributions have now been part of the life of a 401(k) plan for 22 years!

With Section 603, Congress created a nice tax fundraiser by requiring certain catch-up contributions to be funded on a Roth basis.  This seemingly simple change requires a lot of guidance from the IRS and has triggered significant debate among pension professionals on how this should be handled.  As a result of these unanswered issues, neither payroll providers nor recordkeepers were comfortable implementing these rules in absence of guidance by January 1, 2024.  The Notice didn’t answer any of the questions that we’ll discuss below, but promised further guidance that might.

Here’s Where the Unknown Lurks

Let’s go back to review some of the fundamental aspects of how catch-up contributions are required to work.  Treas. Reg. section 1.414(v)-1(e)(1)(i) requires that, if a plan offers catch-up contributions, it must provide the ability to make catch-up contributions to all eligible participants.  This “universal availability” requirement is the one of the elements to the debate about whether plans were required to add Roth contributions to a plan as a result of the Section 603 changes forcing HPIs to make catch-up contributions on a Roth basis.  If I don’t add Roth to my plan, then only non-HPIs can make catch-up contributions, while the HPIs cannot.  If this happens, wouldn’t this be a violation of the universal availability rule?

There is another consideration in addition to the universal availability issue.  Suppose the plan permitted only those who are forced to do so under Section 603 to make Roth contributions.  Would the plan fail the requirement that benefits, rights, and features must be provided on a nondiscriminatory basis, per Treas. Reg. section 1.401(a)(4)-1(b)(3)?  If so, a plan permitting Roth catch-ups for those affected by Section 603 cannot limit Roth contributions to only those catch-ups; it must permit all employees (or, at least, a nondiscriminatory classification of employees) to make Roth contributions.   This issue remains outstanding based on the Notice, requiring later guidance.

The last issue that still remains unknown and was teased out in the Notice as a future guidance point, is the definition of the compensation for determining the $145,000 threshold.  As written in Section 603, this limit would only apply to individuals with FICA wages above $145,000.  This means that individuals who don’t have FICA wages, such as sole proprietors and partners of unincorporated businesses or certain government employees not included in the Social Security program, wouldn’t be subject to this rule.  The IRS indicates in the Notice that this is their line of thinking but fell short of saying so unequivocally.  It’s hard to imagine that business owners will change the structure of their companies just to avoid making catch-up contributions as Roth, but it is important to know how all earners are potentially affected by this new requirement.  So, if a business owner is thinking in these terms, it’s better to wait until the IRS releases definitive guidance.

The Easy Change That’s Coming – Additional Catch-Up Amounts

Don’t forget that Section 109 of the SECURE 2.0 Act also affects catch-up contributions, although not until 2025.  Effective for taxable years after December 31, 2024, Congress has given those aged 60 through 63 an opportunity to save even more money in 401(k) plans (other than SIMPLE 401(k) plans) in anticipation of retirement.  For those four tax years, eligible individuals will be permitted to make catch-up contributions in the amount equal to the greater or $10,000 or 150 percent of the catch-up limitation that would be in effect absent this amended provision.  For example, if the catch-up limitation for someone age 58 is $8,000 in 2025, the limitation for someone age 60 would be $12,000 in that same year.  The higher limit applies to the calendar years in which an individual turns 60, 61, 62, or 63.  It no longer applies to the calendar year in which the individual turns 64.

For SIMPLE 401(k) plans, this added catch-up bump will be the greater of $5,000 or 150 percent of the applicable SIMPLE catch-up limitation.  Using the same above example, in a SIMPLE plan, the catch-up limit for a participant at age 58 is $5,000 in 2025. For the participant at age 60, the catch-up limit would be $7,500 in that same year.

With the delay in the Roth catch-up provision, this special rule for additional catch-ups will actually get implemented first – which is a new twist.  But, at any rate, this is still a section of the new law that needs fleshing out before it becomes effective at the beginning of 2025.

IRA Catch-Up Contributions

Let’s not forget the changes to catch-up contributions for IRAs in SECURE 2.0, Section 108.  Effective for taxable years starting after December 31, 2023, the catch-up limitation will be increased automatically from the $1,000 listed in Code section 219(b)(5)(B)(ii) by an amount equal to $1,000, multiplied by the cost of living adjustment determined by the Chained Consumer Price Index for All Urban Consumers (how many of you even knew that existed?) amended to reflect the taxable year 2022, and rounded to the nearest $100.

What does this mean in layperson’s terms?  The IRA catch-up limit will increase as the cost-of-living increases no more often than annually.

Taking a Breath for a Happy Conclusion

The Notice is certainly good news for all plan sponsors and service providers.  One can only hope that the IRS doesn’t wait until December 2025 to issue further guidance.  If you are, or represent, a plan sponsor that has already amended its plan to add Roth contributions, you are just ahead of the curve and don’t need to retract the amendment.  Continue to offer the Roth option and make the transition in 2025 easier.  If you have amended your plan to remove catch-ups altogether, put them back!

If you have any questions about Notice 2023-62, catch-up contributions, or anything else, call us!  Remember, we are your ERISA solution!

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  • Posted by Ferenczy Benefits Law Center
  • On August 28, 2023