May we recharacterize deferrals mistakenly processed as Roth back to a participant’s proper non-Roth?

[Peter Gulia]

The Treasury’s rule to implement § 414(v)(7)’s requirement that a higher-wage participant’s age-based catch-up deferrals must be Roth contributions includes this:

“Permitted correction on Form W–2. A plan may correct a section 414(v)(7) failure by transferring the catch-up contribution (adjusted for earnings and losses in accordance with § 1.402(g)–1(e)(5)) from the participant’s pre-tax account to the participant’s designated Roth account and reporting the contribution (not adjusted for earnings and losses) as an elective deferral that is a designated Roth contribution on the participant’s Form W–2 for the year in which the elective deferral was originally excluded from the participant’s gross income. However, this correction method may be used only if the participant’s Form W–2 for that year has not been filed or furnished to the participant.” 26 C.F.R. § 1.414 (v)–2(c)(2)(ii) (final and effective, but not yet compiled).

I’m wondering whether a plan’s administration may do the converse: for deferrals that need not have been processed as Roth contributions, transfer that amount (adjusted for investment gain or loss) to the participant’s non-Roth subaccount and wage-report deferral amounts accordingly (if all steps are complete before W-2s run).

The Treasury’s rule doesn’t explicitly say so. Yet, it seems logical and within proper plan accounting. But I hope BenefitsLink neighbors would spot weaknesses in my logic.

Here’s my hypo:

A plan has only elective deferrals, no nonelective or matching contribution. The plan excludes key employees and highly-compensated employees. The plan provides no limit on elective deferrals beyond what’s needed for the plan to tax-qualify.

Suppose a 62-year-old § 414(v)(7)-affected participant has specified non-Roth for all her deferrals (and, despite the employer/administrator’s efforts, has not communicated anything about her preference regarding 2026’s Roth catch-up constraint). Her instruction for deferrals—specified by dollar amount, not a percentage of any measure of compensation—is $1,375 each pay.

Her deferrals for the year’s first 17 (of 26) pays are within the without-catch-up limit. The 18th pay would have most of its deferral allocated to the normal limit, but some to catch-up. And pays 19-26 would be wholly allocated to catch-up.

Imagine the employer, fearing a § 414(v)(7) failure, mistakenly stops this participant’s non-Roth deferrals sooner than is necessary and, applying what the administrator assumes is a deemed election, treats as Roth contributions some of what could properly be non-Roth deferrals. The participant, still inattentive, ignores the employer/administrator’s communications.

On Friday, January 1, 2027, the participant (following her New Year’s Day custom) checks, online, her plan account, and sees the unrequested amounts in Roth subaccounts. On Saturday, she asks her friend, an associate in a law firm’s employee-benefits practice, about this. After hearing him explain the essence of § 414(v)(7), she explains she prefers non-Roth, and wants to tolerate Roth only for a deferral that can’t be made as non-Roth. He suggests, cautiously, that she ask her employer whether it will adjust amounts between the Roth and non-Roth subaccounts. On Monday, the participant calls her employer.

The payroll and human-resources managers both are willing to do adjustments and complete them before W-2s are run, but only if the retirement plan’s third-party administrator says it would be proper.

BenefitsLink neighbors, would you suggest allowing such a Roth to non-Roth transfer?

What issues am I missing?

[Belgarath]

Yes, I'd allow.

[Peter Gulia]

Anyone with a different view?

[BG5150]

Is there something in EPCRS that addresses the issue of an Employer mistakenly deducting (from a paycheck) and depositing Roth funds for a participant when the ppt's election was pre-tax?

In other words I would correct this int he same manner as in my example above, regardless of its relevance to catch-ups.

[Peter Gulia]

BG5150, thank you for the reminder to look into already published administrative law.

If all is adjusted before a W-2 wage report is filed or furnished, might one say there is no failure that calls for even a self-correction?

[PensionPete]

I have had this done with clients in the past and as long as it was all fixed in the same calendar year and all the reporting is corrected by payroll - it was deemed "corrected" - no harm, no foul.  In some cases, payroll had it right, but the deposit to the plan accounts was uploaded incorrectly (an easier situation to correct).  We may have documented the correction of the operation error and self-correction via resolution (especially if the plan is subject to audit - this helps).  I think the key in administration is to ensure someone(s) is always minding the store and proving that.

The split payroll thing between allocating an deferral election between both pre-tax and ROTH (whether deemed or not) will no doubt be an issue next year.  I don't see many participants catching it, let alone catching it timely.  This needs to be a check/limit at the payroll level.