Castle Rock PEP

Mandatory Roth Catch-Up Contributions: Increasing Government Revenues

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Signed into law on December 29, 2022, the Consolidated Appropriations Act includes the Setting Every Community Up for Retirement Enhancement (SECURE) Act 2.0, a significant update to US retirement savings legislation. Comprising over 90 provisions of varying scale and nature, SECURE Act 2.0 offers optional features, allowing plan sponsors to adopt changes they deem beneficial to their plans and participants. However, one mandatory provision has caught attention: starting in 2024, catch-up contributions for highly compensated employees must be treated as Roth contributions. This article delves into this provision and its implications.

Understanding the Provision:

SECURE Act 2.0’s Section 603 stipulates that all catch-up contributions to qualified retirement plans will be subject to Roth tax treatment, effective for taxable years beginning after December 31, 2023. However, an exception is provided for employees with compensation of $145,000 or less (indexed for inflation). Plan sponsors and participants earning over $145,000 should be aware of this change, as it poses essential questions: should the plans introduce Roth accounts, or should they prohibit higher compensated participants from making catch-up contributions?

Roth vs. Pre-tax Accounts:

Roth retirement accounts are funded with after-tax money, which then grows tax-free. Then, when you withdraw the money, it comes out tax-free. This contrasts with traditional pre-tax accounts, where you get a tax break upfront, the money grows tax-deferred, and you owe income taxes when you pull the money out in retirement.
The distinction between pre-tax and Roth accounts may seem complex for the average taxpayer. Consequently, some employers only offer traditional pre-tax retirement accounts. Depending on an individual’s financial circumstances, some taxpayers benefit more from making retirement account contributions on a pre-tax basis, helping reduce their current income and qualify for other tax breaks. Others benefit more from maximizing the amount that goes into the Roth bucket.

SECURE Act 2.0 and Roth Accounts:

Congress aims to expand the use of Roth accounts in SECURE Act 2.0 primarily to increase revenue. The U.S. Treasury receives more money upfront when taxpayers go Roth. In addition, the legislation mandates that all catch-up contributions (extra contributions made by those 50 or older) to workplace retirement plans like 401(k)s be made as Roth contributions.
SECURE Act 2.0 also introduces the option for employers to give employees a choice of receiving employer-matching contributions as Roth money instead of going into the pre-tax bucket of their retirement account, where currently, all employer match goes.
Furthermore, the act allows SIMPLE IRAs to accept Roth contributions and employers to offer employees the option to treat employee and employer SEP-IRA contributions as Roth (in whole or in part).
These provisions under SECURE Act 2.0 are Congress’s many steps to expand Roth usage. They indicate the government’s focus on revenue generation in the near term by encouraging after-tax contributions.

Key Considerations:

The provision raises several issues—first, the compensation calculation. According to the statute, wages from the preceding calendar year from the sponsoring employer exceeding $145,000 determine eligibility. As defined in section 3121(a), these wages adhere to the Social Security definition, potentially leading to accidental discrepancies for plans using different meanings.
Moreover, the plan must allow all eligible participants to make such deferrals for highly compensated participants to make Roth catch-up contributions. If a plan sponsor doesn’t want to permit Roth accounts, participants earning over $145,000 cannot make catch-up contributions. Plan sponsors not currently allowing Roth accounts must consider amending their plans beginning in 2024 to permit higher compensated employees to make catch-up contributions. While plans need not be amended for SECURE Act 2.0 changes until 2025, they must operate according to the Act’s provisions before amending their plans. Furthermore, the $145,000 threshold will be adjusted annually for cost-of-living increases starting after December 31, 2024.
While the implications of these changes may be complex for the average taxpayer, individuals, and plan sponsors must understand these provisions’ tax implications and benefits. The choice between Roth and pre-tax contributions can significantly impact a taxpayer’s current income, tax breaks, and retirement savings growth. As the SECURE Act 2.0 comes into effect, this understanding will be instrumental in making informed decisions to optimize retirement savings.


Concluding Thoughts:


SECURE Act 2.0, with its complexity and stringent stipulations, presents challenges for plan sponsors. More extensive plans and their respective sponsors may possess the internal resources to comprehend and comply with the changes. Still, most mid-sized and smaller employers will require support from their advisors, consultants, and providers.
Given this provision’s effective date of January 1, 2024 (for calendar year plans), plan sponsors must familiarize themselves with this new requirement and make decisions by September or October of the preceding year. This will ensure provider coordination and allow participants to be informed about the changes before the new year commences. The SECURE Act 2.0, while demanding, ultimately serves to enhance the retirement readiness of American workers. By understanding and navigating these new requirements, plan sponsors can help secure their employees’ financial futures.

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