Author: Steven Grieb
On January 13, 2025, the Internal Revenue Service (IRS) proposed new regulations providing guidance for the SECURE 2.0 Act of 2022 (SECURE 2.0) rule requiring some participants to contribute catch-up contributions on a Roth basis only. The proposed rules follow IRS Notice 2023-62, which gave some limited guidance on this directive and provided relief by giving a "2-year administrative transition period," effectively moving back the compliance date.
SECURE 2.0 Roth catch-up rule
Under SECURE 2.0, any 401(k) plan, 403(b) plan or governmental 457(b) plan that permits participants to make catch-up contributions must require such contributions to be designated Roth contributions, starting in 2024 (the Roth catch-up rule). As indicated, the IRS pushed back the practical effective date until 2026. This restriction will only apply to participants whose compensation during the prior year exceeds $145,000 (as adjusted annually for inflation).
Participants who earned $145,000 or less in the prior year can still defer catch-up contributions on a pre-tax basis. Participants who are over age 50 and earn more than $145,000 may not elect to make their catch-up contributions on a pre-tax basis. The Roth catch-up rule wouldn't apply to SIMPLE IRA plans or SEP plans. Offering catch-up contributions is optional for qualified retirement plans. However, if a plan allows participants to make catch-up contributions, the new Roth catch-up rule will be mandatory.
As the 2026 deadline for the Roth catch-up rule approaches, many in the retirement plan industry are concerned about the ability of plan sponsors to properly apply the rule on a timely basis. There are numerous issues on which plans require guidance. And from an administrative standpoint, there also are questions about who bears responsibility for making certain that the rule is properly implemented. The IRS's proposed regulations address many of the questions that have been raised.
Applying the Roth catch-up rule
The proposed rule updates the treasury regulations to provide that a participant who is subject to the Roth catch-up requirement is deemed to have irrevocably designated any catch-up contributions as a Roth contribution. Once a participant who's subject to the rule reaches an applicable deferral limit, the plan can deem the participant to have elected that the catch-up contributions be made on a Roth basis. Of course, the participant must be allowed to stop or change deferrals if they wish.
The proposed regulations point out that a participant must reach an applicable limit (such as the 402(g) limit on elective deferrals, the 415 limit on overall accruals or a plan-imposed limit) before becoming eligible to make catch-up contributions. If a participant makes Roth contributions prior to an applicable limit being reached, those Roth contributions will be considered for purposes of determining whether the Roth catch-up rule is met. Consequently, participants who have already made some Roth contributions could make some catch-up deferrals on a pre-tax basis.
Some plan administrators have asked if they could simplify plan operations by merely requiring all catch-up contributions to be made on a Roth basis. The proposed rules don't expressly allow for that plan design. As a result, until the IRS issues additional guidance that expressly allows for that approach, plan sponsors should avoid this tactic.
Who is subject to the Roth catch-up rule?
When determining which participants have earned more than $145,000 in the prior year, SECURE 2.0 uses Federal Insurance Contributions Act (FICA) wages. The proposed regulations specify that anyone who didn't have FICA wages from the employer in the previous year can make pre-tax catch-up contributions. This excludes from the Roth catch-up rule a partner who only had self-employment income, or a state or local government employee that is not subject to FICA withholding.
Significantly, the proposed rules indicate that the plan only needs to consider compensation paid by the "employer sponsoring the plan," disregarding other entities in the controlled group. For example, if there are multiple controlled group members participating in a single plan, each of the participating employers would be treated as a separate employer when determining the prior-year compensation. Additionally, the regulations don't require that the Roth catch-up wage threshold be prorated for the first year of hire. A participant hired during the prior year would be subject to the full Roth catch-up threshold amount only if they earned the full $145,000 from the employer, regardless of when they were hired during the year.
Universal availability rule
The Internal Revenue Code contains a universal availability rule for catch-up contributions. Under this requirement, all catch-up eligible participants must be provided with an effective opportunity to make the same dollar amount of catch-up contributions. However, if a plan doesn't offer Roth contributions, then participants who earn more than $145,000 in the prior year will have a catch-up contribution limit of $0.
The proposed regulations address this situation by providing that plans that don't offer a Roth feature won't violate the universal availability requirement merely because the plan disallows participants who are subject to the Roth catch-up rule from making catch-up contributions. Consequently, a plan that doesn't offer Roth contributions to participants can still allow for catch-up contributions, but only for participants who didn't earn more than $145,000 in the prior year.
Correcting Roth catch-up errors
If a participant subject to the Roth catch-up rule makes a pre-tax deferral above an applicable limit, the plan must correct the error. That creates a significant concern when a highly compensated employee's pre-tax deferral is re-classified as catch-up after the fact to correct a nondiscrimination testing failure. Generally, the plan would need to correct the error by distributing to the participant the amount of funds that exceeded the pertinent limit. On a positive note, the proposed regulation gives two additional correction possibilities:
- First, if the correction happens before the participant receives their Form W-2, the plan can transfer the catch-up amount (adjusted for earnings) from the participant's pre-tax account to their Roth account. The unadjusted amount would be included in the participant's taxable income for the year of the deferral.
- Second, before or after the Form W-2 is issued, the plan could perform an in-plan Roth rollover from the pre-tax account after adjusting the catch-up amount for earnings. The adjusted amount would be included in the participant's taxable income in the year of the deferral.
Increased catch-up limit for certain years
On a related note, SECURE 2.0 also contained a rule allowing increased catch-up contributions for some participants. Specifically, the statute provides for higher catch-up limits during the taxable years that the participant attains age 60, 61, 62 or 63. If a participant turns 64 during the taxable year, they cannot take advantage of the higher limit for that year. This rule becomes effective for taxable years beginning in 2025. The proposed rule updates the treasury regulations to reflect the increased catch-up limit for those years.
For the four years in question, the increased limit will be the higher of $10,000 (adjusted for inflation) or 150% of the otherwise applicable catch-up limit. The general limit is annually adjusted for inflation. For 2025, the catch-up limit equals $7,500. Consequently, the increased catch-up limit for the 2025 taxable year equals $11,250. Of course, if the participant is subject to the Roth catch-up rule, any catch-up contribution must be made on a Roth basis, including the additional catch-up.
Unlike the Roth catch-up rule, the increased catch-up limit is an optional feature. Plans could decide to continue a uniform catch-up limit for all employees. However, catch-up provisions are extremely common, and we anticipate that many plans will elect to offer the higher limits for eligible participants. The proposed rule amends the treasury regulations to make clear that offering the increased catch-up amount won't cause a plan to violate the previously discussed universal availability rule.
Applicability date
The proposed rules will apply to taxable years that begin more than six months after the date the final regulations are issued. Until then, plan administrators should follow a reasonable interpretation of the SECURE 2.0 rules regarding Roth catch-up and increased deferral limits. The IRS has indicated that complying with the terms of the proposed regulations would be reasonable. As a result, plan administrators should strongly consider following the guidance as described above.
Gallagher insight
The proposed regulation provides some much-needed answers, particularly regarding the Roth catch-up rule. However, properly implementing the new Roth catch-up rule will require coordination with the plan's recordkeeper, payroll provider, third-party administrator (TPA) and perhaps other service providers.
Plan sponsors should use the 2025 year to work toward getting all necessary parties on board with full compliance. As always, your Gallagher consultant is here to help with any questions or assist in getting all stakeholders on the same page.
