The SECURE 2.0 Act introduced a requirement that, effective January 1, 2024, 401(k) catch-up contributions made by highly compensated employees (HCEs) must be made on a Roth (after-tax) basis. IRS Notice 2023-62 offers stakeholders two important points of relief:
- 2-Year Implementation Delay: The SECURE 2.0 provision provides important relief to the practical problems created by this provision. The Notice effectively delays the effective date of that provision for two years until 2026 (via implementing an administrative transition period). This will give plan sponsors, recordkeepers, and payroll providers additional time to create the infrastructure required to implement this provision.
- Catchup Contributions Okay: The notice also clarifies that catch-up contributions (pre-tax or Roth) can continue to be made for tax years beginning after 2023. This is important because a technical drafting error in the SECURE 2.0 law effectively eliminated catch-up contributions for all employees (pre-tax and Roth) for 2023 and beyond. It is generally accepted that this was not the legislative intent. However, the regulatory “blessing” that catch-up contributions can still be made is a welcome clarification.
The Timing Problem
The Rothification requirement for HCE catch-up contributions created significant administrative challenges for plan sponsors, recordkeepers, and payroll providers alike.
- Short Runway: With the effective date of this provision being January 1, 2024, the runway for implementation is exceptionally short. This has proven challenging for all stakeholders. Specifically, significant infrastructure changes are required to implement this provision, and the runway for designing, coding, implementing, and testing systems is very short.
- Identifying Highly Paid Participants: Plan sponsors, recordkeepers, and payroll providers have struggled to construct processes that appropriately identify highly paid participants such that their catch-up contributions can be restricted to/converted to a Roth basis.
- Communication to Highly Paid Participants: Plan sponsors have struggled with communicating the requirement to make catch-up contributions on a Roth basis because many Highly Paid Participants may only be identified very late in the calendar year (when catch-up contributions may have already been made on a pre-tax basis).
- If No Roth Provision, No Catch-Up Contributions: Plans that do not provide for Roth contributions (at all) are faced with the requirement to add a Roth option or eliminate the ability for Highly Paid Participants to make catch-up contributions at all.
The IRS provided a two-year administrative transition period through December 31, 2025. During this transition period, plans may continue to allow high-paid participants to make pre-tax catch-up contributions without being in violation of this provision of the SECURE 2.0 Act. Additionally, plans that do not have Roth features may continue to allow catch-up contributions. Note that this relief is temporary (through 2025) and does not eliminate the need to address the challenges related to implementing this provision.
The Drafting Error Problem
The SECURE 2.0 law inadvertently strikes specific language from the Internal Revenue Code that, if read strictly, prohibits all participants from making catch-up contributions (pre-tax or Roth), after December 31, 2023. In a perfect world, a legislative correction would be passed to address this error. However, in the absence of such legislation, the regulatory authorities provided a statutory interpretation for how catch-up contributions can continue, even given the drafting error.
Preview of Other Expected Guidance
The IRS also provided a preview of expected future guidance, including:
- Employers would be permitted to treat pre-tax elections by participants subject to the new catch-up contribution rule as Roth elections. This eliminates any requirement to affirmatively seek Roth elections from participants that don’t otherwise have a choice for their catch-up contributions.
- When determining whether an individual is a high-paid participant in a multi-employer plan, employers may consider wages only from the employer sponsoring the plan; employers are not required to aggregate wages with unrelated participating employers in the plan.
- If an individual does not have wages (with the employer sponsoring the plan) that are subject to FICA in the prior year, that individual is deemed to NOT be a high-paid participant.
This previewed guidance is not final and could be changed in the future. However, the fact that the IRS was willing to go on the record with this guidance suggests a high likelihood that it will be issued in some form.
Employer Action Item
While this guidance and the two-year delay is a relief, employers should continue to work closely with recordkeepers and payroll vendors to confirm that their vendors are on track to implement these provisions by January 1, 2026.
IRS Notice 2023-62 can be referenced here.