Understanding Roth Contributions

Unlike traditional pre-tax deferrals, which reduce taxable income in the year they are made, Roth contributions aren’t deductible. However, their advantage lies in the tax treatment upon withdrawal: both the contributions and their earnings can be withdrawn tax-free in retirement, provided certain conditions are met, such as reaching age 59½ and having held the account for at least five years. 

Immediate and Long-Term Tax Implications

For higher-paid employees affected by this mandate, the immediate implication is an increase in taxable income, as Roth contributions are made with after-tax dollars. This could result in a higher tax liability in the contribution year. However, the long-term benefit is the potential for tax-free income during retirement, which can be advantageous if future tax rates are higher or if the retiree’s income places them in a higher tax bracket.

The catch-up contributions for higher-paid participants must be treated as Roth deferrals.

Preparing for the 2026 Changes

Employers should take proactive steps in 2025 to ensure a smooth transition:

1. Decide Whether to Add Roth Accounts. The catch-up contributions for higher-paid participants must be treated as Roth deferrals. However, to allow those higher paid participants to make deferrals, all catch-up-eligible participants must be allowed to make Roth contributions. If a plan doesn’t currently allow Roth deferrals, the plan sponsor will need to make a decision about whether to add them for 2026. If Roth deferrals aren’t allowed by a plan, the eligible higher compensated participants won’t be able to make catch-up contributions at all. Note, the IRS has said that plans don’t have the option of requiring that all catch-up contributions be treated as Roth deferrals. In other words, catch-up-eligible participants who made $145,000 or less in the preceding year must have the option of choosing to make Roth or pre-tax catch-up contributions.
2. Review and Amend Plan Documents: Confirm that the retirement plan permits Roth contributions. If not, amendments will be necessary to accommodate the mandatory Roth catch-up contributions for high earners. 
3. Update Payroll and Recordkeeping Systems: Coordinate with payroll providers to accurately track employee compensation, and identify those exceeding the $145,000 threshold. For example, the plan and the payroll system will need to be able to identify the catch-up-eligible participants who make over $145,000 in 2025 in order to know whose catch-up deferrals in 2026 will have to be treated as Roth deferrals. Systems also must be capable of distinguishing between pre-tax and Roth contributions.  
4. Employee Communication for the Affected Participants: Work with the plan’s recordkeeper to develop a communication strategy to inform affected higher paid employees about the changes, and to give them the opportunity to continue to defer as Roth catch-up contributions or to stop making catch-up contributions. (Note that the IRS will allow plan sponsors to continue prior deferral elections and to treat catch-up contributions as Roth, if a higher paid participant doesn’t file a new election.)

In addition, if the plan didn’t previously allow Roth deferrals, the catch-up-eligible participants who make less than $145,000 should be told of their right to decide between Roth and pre-tax deferrals, and to make an election before the beginning of the 2026 year.

Plan sponsors may also want to offer educational sessions, and/or materials on the differences between pre-tax and Roth contributions, the reason for the changes, and warning that payroll withholding may need to be increased due to the loss of the deductions.

Implementing Roth Deferrals in Existing Plans

For plans that don’t currently offer Roth deferral options, implementing this feature involves several steps:

• Plan Amendment: Draft and adopt amendments to include Roth contribution provisions.
• System Configuration: Update administrative and payroll systems to process Roth contributions, ensuring accurate tax reporting and recordkeeping.
• Participant Elections: Establish procedures for participants to elect Roth contributions, including necessary forms and disclosures.

It’s crucial to ensure that all catch-up eligible participants, not just those exceeding the income threshold, have the option to make Roth catch-up contributions. 

Exceptions to the Requirement

The provision in SECURE 2.0 that included this new requirement said that the determination of which employees made over $145,000 is based on FICA “wages” as defined in section 3121(a) of the Internal Revenue Code (as opposed to, e.g., adjusted gross income). While that may seem like a technical distinction, it does have some practical effects. For example, sole proprietors, and partners in partnership don’t have FICA wages. As a result, the new requirement doesn’t apply to them, because by definition their FICA wages are -0-. In other words, this new requirement doesn’t apply to sole proprietors or partners.

Conclusion

The SECURE 2.0 mandate for Roth catch-up contributions for higher-paid employees is a significant change—and, by definition, it affects the more highly-paid employees, including the officers and key employees of a plan sponsor. As a result, financial professionals can provide valuable help to plan sponsors by educating them on this upcoming change as early as possible in order to allow for an orderly process to make decisions, to educate the affected employees, and to allow for new deferral elections. In addition, financial professionals can provide a valuable service by explaining the consequences, advantages, and disadvantages of Roth treatment to the affected employes—and thereby helping them make informed decisions. 

By taking proactive steps in 2025, employers can ensure compliance and assist employees in navigating these changes in an informed manner. Clear communication and thoughtful implementation will be key to a successful transition.