IRS Issues Guidance on Roth Option for Employer Contributions
A qualified Roth contribution program is an optional plan design feature allowing participants in 401(k), 403(b), and governmental 457(b) plans to accumulate after-tax retirement savings by designating their salary reduction contributions as Roth contributions rather than as traditional pre-tax contributions. This client alert addresses recent IRS guidance on expanded options for Roth contribution programs pursuant to the enactment of SECURE 2.0 in December 2022.
Prior to SECURE 2.0, qualified Roth contribution programs were limited to employee salary reduction contributions. Any employer matching or nonelective contributions were required to be made pre-tax, even if they were made on behalf of employees who had designated their salary reduction contributions as Roth contributions.
Section 604 of SECURE 2.0 changed that. An employee may now be permitted to designate employer matching and nonelective contributions as well as salary reduction contributions as Roth contributions. This means that a participant in a plan offering this expanded choice, together with an in-Plan Roth conversion feature for any prior pre-tax amounts, could retire with a plan account consisting entirely of Roth contributions and earnings thereon.
Section 604 was effective as of December 29, 2022. However, employers and service providers have been reluctant to expand their Roth contribution programs absent IRS guidance on important questions unaddressed in the statute, such as income inclusion and vesting requirements. Therefore, adoption of the expanded options in 2023 has been minimal at best.
The IRS has now provided initial guidance. Notice 2024-2 was released on December 20, 2023 and addresses twelve discrete provisions of SECURE 2.0, including the expanded Roth contribution program. This guidance is distinct from Notice 2023-62 which provided an administrative transition period for the separate requirement under Section 603 of SECURE 2.0 that certain catch-up contributions be made as designated Roth contributions for taxable years beginning after December 31, 2023. Our August 29, 2023 client alert discusses Notice 2023-62.
Pursuant to Notice 2024-2, designated Roth matching and nonelective contributions are:
- An optional plan design feature. A plan may offer designated Roth contributions with respect to all, any, or none of employee salary deferrals, employer matching contributions, and employer nonelective contributions. If offered, an employee must have the option to change their designation at least once during each plan year. (Offering at least a limited Roth contribution program may become mandatory for some plans after the administrative transition period under Section 603 of SECURE 2.0 has expired.)
- Only available with respect to a contribution type in which the employee is fully vested at the time the contribution is allocated to their account. This will not result in a failure of the otherwise applicable nondiscrimination requirements.
- Includible in an employee’s gross income for the taxable year in which the contributions are allocated to their account. This applies regardless of when the contributions are deemed to have been made.
- Not included in an employee’s wages for purposes of federal income tax withholding. Notwithstanding, an employee may need to increase their withholding or make estimated tax penalties to avoid underpayment penalties.
- With the exception of certain governmental plans, not included in wages for purposes of Social Security and Medicare taxes (FICA). Also, they are not included in wages for purposes of Federal Unemployment taxes (FUTA). The existing treatment of Roth salary deferrals as wages for purposes of FICA and FUTA remains unchanged.
- Reported using Form 1099-R for the year in which the contributions are allocated to the employee’s account.
- Not included in the safe harbor definitions of compensation under Treasury regulations 1.415(c)-2(d)(3) and (d)(4).
Notice 2024-2 is explicit that it is not intended to provide comprehensive guidance, but rather to assist in commencing implementation of the provisions it addresses. Further guidance, including regulations, is anticipated. Pending such guidance, employers interested in adopting or expanding a qualified Roth contribution program may wish to consider:
- Vendor support. Third party administrators are not required to support expanded Roth contribution programs, so as a practical matter employers may be dependent on what their service providers decide to offer pursuant to Notice 2024-2.
- Documentary compliance. Employers using pre-approved documents should coordinate with their document providers, and employers using custom documents will want to draft amendments and adopt them by the applicable deadline for discretionary plan amendments.
- Participant communications. Even participants already familiar with designated Roth salary reduction contributions may require education on the tax consequences of designating employer contributions as Roth contributions, and some communications will be legally required.
- Reporting requirements. As a general matter, Form 1099-R is not issued to most active plan participants, especially annually. An expanded qualified Roth contribution program may significantly increase the required annual reporting.