SECURE 2.0 Roth Catch-up - Automatic Spillover

[Gruegen]

Pursuant to Section 603 of the SECURE Act and starting with the 2024 calendar year, if FICA wages in the previous calendar year (2023) exceeded $145,000, the catch-up contributions under IRC 414(v) must be made to a designated Roth account under the Plan. If a participant elected pre-tax 401(k) contributions in 2024 and the participant reaches the dollar amount permitted under IRC 402(g) in the middle of 2024 (i.e.- September, 2024), is it possible for the plan to be designed to withhold Roth 401(k) catch-up contributions for the remainder of the 2024 year (i.e., September-December, 2024) up to the IRC 414(v) limit (i.e., $7,500)? The SPARK Institute's  Comment Letter to the IRS (April 10, 2023) requests IRS guidance that permits this automatic spillover:

• The SPARK Institute requests confirmation that employers and plan administrators can rely on negative consent to switch employee elections from pre-tax elective deferrals to designated Roth contributions in order to prevent any existing election from violating SECURE 2.0’s requirement for Roth catch-up contributions.

I was just checking to see if recordkeepers and/or payroll companies have considered this automatic spillover as a feature that they are planning to build, support and administer in their SECURE 2.0 projects.  

[Lou S.]

Only if the IRS issues guidance on how the spillover is taxed and reported. But once that happens, I'd expect that to be the default among asset most vendors.

I mean who wants to send money back to a participant when they can keep it and earn asset management fees?

[Peter Gulia]

Might some higher-paid employees’ deferrals reach a need to use a § 414(v) catchup as soon as January 2024?

Imagine 2024’s § 401(a)(17) limit might be $340,000 and 2024’s § 402(g) limit (without an age-based catchup) might be $23,000. Imagine 2024’s § 414(v)(2)(B)(i) amount might remain $7,500.

Assume a plan provides a nonelective contribution of 3% of compensation.

Assume the plan permits elective deferrals up to 97% of compensation.

An employee is 51 years old.

The employee’s base pay (all of which is wages) is $1 million for 2024.

Assume monthly pay periods.

$1 million / 12 = $83,333.33.

$340,000 / 12 = $28,333.33.

$28,333.33 x 97% = $27,483.33

In a continuing cash-or-deferred election made in 2023 to apply for compensation after 2023, the employee had elected deferrals of 97% of compensation, had elected these deferrals be non-Roth to the extent the plan permits, and had elected that any portion of her deferral not allowable as non-Roth be treated as Roth. (To remove the implied-election question from our hypothetical, imagine the employee made, before 2024, all these elections as affirmative written elections.)

For this employee’s first 2024 pay, $23,000 is non-Roth elective deferrals, and $4,483.33 is Roth elective deferrals.

Even with these $27,483.33 in retirement plan deferrals, the employee’s January pay will have another $55,850 available for withholding taxes and other pay deductions.

Or am I missing something?

To return to Gruegen’s query, some plans’ administrators might need to form one’s interpretation about whether an administrator may (or must not, or should not) rely on implied assent to treat elective deferrals as Roth contributions without waiting for the hoped-for government guidance.

And recordkeepers might estimate how many plan administrators will want such a service feature.

[jsample]

It is not uncommon for employees to contribute up to their deferral and catch-up limit in January 2024.  Some employers will pay earned bonuses from 2023 in January, 2024.  I have had employees contribute 100% of their January bonus, which many times is the 401k plus the catch-up limit.

I have heard a few recordkeepers say that their game plan will be to notify all employees, who have earned over $145,000 in November, 2023, with a publication that explains this new regulation.  The publication will explain that if the employee does not reply with an election to not make their catch-up, by default their catch-up will be contributed as a Roth contribution.  Some recordkeepers are trying to make this happen without having to reenroll participants.  I'm not sure that this will work, but that is one of the current thought processes. 

[Peter Gulia]

With some (or many) participants, a plan might have three layers of implied-assent choices:

1.    Whether a participant is deemed to have chosen a deferral;

2.    The default amount of an implied-assent deferral; and

3.    For a § 414(v) catchup portion of a deferral (even if the deferral results from affirmative elections), a default presumption of Roth-ing that portion; rather than no deferral for the portion that cannot be non-Roth deferrals.

If the Internal Revenue Service doesn’t publish the requested guidance soon enough, there might be an implied-assent choice in another frame:

A recordkeeper might propose to its customer plan fiduciary a #3 implied assent for a participant in the $145,000 group as an interpretation of uncertain law that the plan fiduciary approves, and instructs the recordkeeper to use in providing the recordkeeper’s services.

[Paul I]

Having a default that automatically begins Roth catch-up contributions when a High Paid individual reaches the 402(g) limit could be a problem for that individual.

The problem stems from the fact that payroll will withhold federal and state taxes on the Roth amount.  The dollar amount of the deferral will not change and will be contributed to the plan (and likely be unavailable for in-service withdrawal).  The individual's net pay will be less by the amount of additional income taxes withheld.  One can reasonably assume that an individual who chose not to make an affirmative election on the whether to make catch-up contributions is less likely to consider the impact of taxes on net pay.

It is not uncommon for plans - particularly smaller plans - to allow changes in deferral elections including catch-up contributions less frequently than every pay period.  The net tax issue will be amplified if the individual wants to make a change to restore net pay and then learns the individual has to wait until the change can be implemented under the plan.  In most plans, the only option then available would be to suspend deferrals until the change can be implemented.

[Peter Gulia]

An administrator’s (or recordkeeper’s) desire for the implied-assent election jsample described results because many plans use continuing cash-or-deferred elections, and some participants might have made, before 2024, elections under assumptions that become, in 2024, no longer true.

While it’s better for a participant to be attentive and make considered choices, individual-account retirement plans’ administration has, for better or worse, adapted to filling-in some presumptions for those who do not communicate an affirmative instruction.

Without doubting anything Paul I explains, sometimes recordkeepers do what they can with the law Congress provides.