The SECURE 2.0 Act of 2022 brought several changes to retirement plans. However, one may be of particular interest to plan sponsors: the option to allow employees to elect to treat employer contributions as Roth contributions. This provision is likely to be attractive to employees as it expands the strategies available to them as they save for retirement. But there are important issues to navigate as the dust from the recently passed legislation settles.
In this post, we break down key information about the change and recommend next steps for plan sponsors who may be interested in offering this feature to their employees.
What Do Plan Sponsors Need to Know About This Change?
Before the SECURE 2.0 Act — which was part of the Consolidated Appropriations Act of 2023 that was signed into law on December 29, 2022 — employer contributions made to 401(k), 403(b), or 457(b) plan accounts were only allowable on a pretax basis; such contributions couldn’t be classified as after-tax Roth. Effective December 29, 2022, employers can allow employees to elect to have their matching or non-elective contributions made on an after-tax Roth basis.
In order to take advantage of this new option, employees will need to be fully vested in their employer matching or non-elective contributions. They will also need to formally elect for the employer contribution to be Roth and will be required to pay taxes on such contributions. Plan sponsors will still be able to deduct these employer contributions just like other pretax-based employer contributions.
Offering this new feature is optional for employers, and providing it will require amending your plan documents. The earliest that plans to adopt this change will need to be amended is the last day of the first plan year beginning on or after Jan. 1, 2025. It is also important to note that while employers are allowed to implement this feature immediately, it may not yet be technically possible due to potential tracking and reporting issues, as well as concerns about the process of directing deposits into the appropriate sources in the plan accounts.
Key Considerations for Reporting and Tracking
As with any new legislation, there are still questions to be answered about the practicality of implementation. Currently, it is not clear how employees who choose to formally elect Roth employer contributions will be documented and reported to appropriate entities such as the government and service providers.
Experts expect this process will be similar to a deferral election, in which case recordkeepers would track Roth contributions. However, service providers still need to update their systems to accept and track this new type of contribution. And many service probers are waiting for additional guidance from the IRS before investing resources in these updates.
There is also a question of how to report the taxes owed on the newly designated Roth employer contributions. These could potentially be reported on Form 1099-R (which would only capture income taxes) or Form W-2 (which would capture both income and employment taxes). The IRS may also choose to create new Roth election forms. It is also unclear if these elections will need to be made just once or annually. With so many outstanding questions about the implementation of this option, the potential rollout of this feature may be on pause until additional guidance is made available.
Next Steps for Plan Sponsors
For plan sponsors who may be interested in offering this new option, there are some actions you should take now. First, speak with service providers as soon as possible to determine how this feature may work for their organization. While the rollout is just beginning, speaking with your providers may encourage them to establish the required systems more quickly if they have not begun the process already.
Although employers don’t need to immediately amend their plans to allow for this feature, plan sponsors that are interested in offering it should carefully document their process so all of the proper provisions are covered when it is time to prepare the amendment.
Finally, plan sponsors should be prepared to provide educational resources to employees around new retirement savings options. Most participants will likely be unfamiliar with the tax implications of moving to a Roth matching or non-elective contribution.
Participants will need to understand that Roth employer contributions will be included in their gross taxable income and be subject to regular withholding rates and that significant contributions may push them into a higher tax bracket. It is always best practice for plan participants to discuss their retirement planning and elections with a tax advisor to ensure it best fits their needs and goals.
Insight: Compare Your Options Carefully
Even before the passage of SECURE 2.0, plan sponsors offering Roth deferrals could allow participants to do an in-plan conversion of monies from a Pretax 401(k) or 403(b) to a Roth account.
So, is it better for plan sponsors to keep the Roth conversion provision in place, move to the new SECURE 2.0 feature, or allow for both? The answer to this question will depend on several factors, and plan sponsors should take action now to understand both approaches in order to determine the best course of action for their organization.