Participants who made more than $145,000 in “wages” in 2023 will have their catch-up contributions treated as Roth deferrals. 

While much of the early attention was given to provisions such as matching contributions for student loan payments, tax credits for new retirement plans, and mandated automatic enrollment for new plans, a different provision is emerging as one of the most problematic. That is section 60 of the Act, which mandates that, in 2024, participants who made more than $145,000 in “wages” in 2023 will have their catch-up contributions treated as Roth deferrals. To complicate matters, the law also requires that the other catch-up eligible participants (i.e., those making $145,000 or less) must be allowed to elect for their catch-up contributions to be Roth.

What if a plan sponsor doesn’t want to add Roth to its plan? The answer is probably unacceptable. In that case, the plan must prohibit catch-up contributions for all participants.

That’s the outcome. This article has a more detailed discussion starting with the Senate Finance Committee’s summary of the provision:

Section 603, Elective deferrals generally limited to regular contribution limit.
Under current law, catch-up contributions to a qualified retirement plan can be made on a pre-tax or Roth basis (if permitted by the plan sponsor). Section 603 provides all catch-up contributions to qualified retirement plans are subject to Roth tax treatment, effective for taxable years beginning after December 31, 2023. An exception is provided for employees with compensation of $145,000 or less (indexed).

Note: The odd provision at the end reflects a last-minute change to the provision. Before that happened, the bill would’ve required that all catch-up contributions be treated as Roth.

When considering the impact of this change, as a practical matter, plans can be divided into three categories:

• Plans that don’t offer Roth deferrals and don’t allow catch-up contributions. While very few plans fall into this category, this is the one category that doesn’t have to address the problems created by the new provision.
• Plans that offer both Roth deferrals and catch-up contributions. In this case, the plans need to educate their higher-paid participants about the 2024 Roth treatment of their catch-up contributions so that those participants can decide whether to make catch-up contributions or not. These plans won’t need to be amended until 2025 when they will need to clarify the Roth treatment for the catch-up contributions of the higher-paid participants.
• Plans that offer catch-up contributions, but don’t offer Roth deferrals. This is the most problematic group. The plans in this category need to decide to either (i) add Roth deferrals or (ii) to eliminate catch-up contributions. Whichever decision is made, the plan will need to be amended currently to document the decision. (While there is an argument that the amendment could be delayed until 2025, there is risk in doing that.) Based on my conversations with employers so far, it appears that most will be adding Roth deferrals to their plans.

Theoretically, there’s a fourth category—plans that allow Roth, but not catch-up contributions. In the rare case of such a plan, the plan is safe for now. No need to make any administrative or document changes.

The obvious question at this point is, why is this provision so difficult administratively?

Part of the complexity is that implementation of the provision requires coordination among plan sponsors, payroll providers, and recordkeepers. It also requires programming of systems at recordkeepers and payroll providers. It appears that most recordkeepers will be able to administer Roth catch-up contributions by the start of 2024. However, some payroll providers may not be ready in time. As a result, plan sponsors and financial professionals who support those plans should be talking with the payroll providers to determine whether they’ll be able to manage the new requirements for catch-up contributions in 2024. If not, the affected plans may need to stop accepting catch-up contributions until the payroll provider can support the change.

Another issue is that the determination of who’s in the over $145,000 category (called “higher-paid” in this article) in 2023 can’t be made until early 2024, which means that some catch-up deferrals could be made before it’s known if they’re required to be Roth. This issue can be mitigated if the plan uses the “spillover” method of administering catch-up contributions. The spillover method treats the first deferrals as being under the regular deferral limits, with the catch-up contributions only occurring after the regular limit is reached. Under the spillover method, catch-up contributions wouldn’t ordinarily occur later in the year. (The alternative to the “spillover” approach is the “separate contribution” election, where a participant makes two elections—one for regular deferrals and one for catch-up contributions—and both are deducted from the participant’s paychecks over the course of the year.)

Yet another problem is that the $145,000 compensation amount is calculated on the same basis as FICA wages for Social Security taxes, which in most cases will be different than the definition of compensation for other plan purposes. As a result, plan sponsors and their payroll providers will need to develop the methodology for calculating the FICA wages for higher compensated participants in the year before Roth treatment applies for catch-up contributions. That information will also need to be communicated to the affected participants so that they can decide whether to continue to make catch-up contributions. It will also need to be communicated to the plan’s recordkeeper so that the catch ups can be allocated to the affected participants’ Roth accounts.

To further compound matters, the $145,000 amount isn’t used for any other provision of the Internal Revenue Code’s regulation of retirement plans, so this is a new standard for plan sponsors, payroll providers, and recordkeepers to apply.

Using the FICA definition of wages means high-earning sole proprietors and partners won’t be affected by the new provision.

Interestingly, one of the effects of Congress using the FICA definition of wages for this purpose is that high-earning sole proprietors and partners won’t be affected by the new provision. Neither sole proprietors nor partners earn wages. Instead, a sole proprietor earns profits on a Schedule C to his or her 1040, while partners’ earnings are reported as a share of profits on a K-1. (Note that there is some concern that the IRS could try to interpret the FICA wages provision in a manner that would capture higher-earning partners and sole proprietors, but the statutory provision is explicit, suggesting that such an extension is not supported by the law. It’s also possible that Congress could subsequently amend the provision to include partners and sole proprietors, but that is, if at all, in the future.)

As a final example of the complexities of the new provision, there are other unanswered questions. For example, if a plan fails its discrimination testing and the failure is avoided by reclassifying a regular deferral as a catch-up contribution after the end of the year (e.g., in 2025 for the 2024 plan year), must that reclassified deferral be treated as Roth and, if so, is it taxed to the higher-paid, catch-up eligible participant in 2024 or 2025?

There are a host of legal interpretative issues, such as the timing of taxation, that the IRS needs to provide guidance on. Unless that guidance comes in the very near future, it‘ll be difficult, perhaps impossible, for recordkeepers and payroll providers to complete their programming for this new requirement and then to coordinate with plan sponsors on a timely basis. Time is of the essence. Hopefully, the IRS will, at the least, provide relief for good-faith reliance on reasonable interpretations.

Concluding Thoughts

While recordkeepers are taking the lead on developing compliant processes, educational materials, and election forms for this new provision, there’s a real need for financial professionals to educate their plan sponsor clients about the Roth catch-up provision and its administrative issues. That’s particularly true for plans that allow catch-up contributions but not Roth deferrals. In that case, a plan amendment will be needed by year’s end. While most of those plan sponsors will probably decide to add a Roth provision, the key is to help them make well-informed decisions. Because of their personal relationships with their plan sponsor clients, financial professionals are in a unique position to provide them with that important help.

Note: There’s a push for congressional relief. Many trade associations, plan providers, and large plan sponsors are requesting an extension of the effective date of this provision until 2025 or even 2026. At this time, it’s just an effort. No legislation has been introduced at the time of the writing of this article.