A higher-paid employee’s catch-up must be Roth deferrals—how to implement?

Soon (unless Congress changes the law, or the IRS publishes another nonenforcement), for a participant whose FICA wages from the employer in the preceding calendar year was more than $145,000 (or the inflation-indexed amount), an age-based catch-up deferral must be made only as Roth deferrals. For those participants, non-Roth deferrals are allowed only up to the without-catchup elective-deferral limit (or the plan’s constraint, including a constraint that follows a nondiscrimination measure).

On January 13, 2025, the Treasury published a proposed rule stating interpretations of Internal Revenue Code § 414(v)(7) and related tax law.

That notice includes some ways an employer might treat an affected participant’s election to make non-Roth deferrals as, to the extent of what would be beyond the without-catchup elective-deferral limit, a deemed election to make Roth deferrals.

I’ve heard about (at least) two ways an employer and its recordkeeper might use such a deemed election:

1.     Starting with the first pay period of 2026, adjust a § 414(v)-affected participant’s per-pay amounts or percentages between non-Roth and Roth deferrals so they would result in fitting amounts for 2026 if one assumes a participant remains employed throughout the year and makes deferrals in every pay period of the year.

2.    During 2026, apply a participant’s election for non-Roth deferrals until the sum of those deferrals reaches the year’s without-catchup elective-deferral limit. Then, treat any further deferral as Roth deferrals, until the year ends.

Are both those ways logically consistent with the Treasury’s proposed rule?

If not, which way does not fall in with the proposed rule?

If there is a choice, which way would you suggest? And why?

If you like way 1 (starting with the first pay period), what adjustment would you allow if the participant’s employment ended before the year ended and this would result—without an adjustment or reclassification—in not filling-up with non-Roth deferrals all that may be done within the year’s without-catchup elective-deferral limit?

In thinking through your suggestion and reasoning, assume: your client is the employer; the plan has hundreds or thousands of § 414(v)-affected participants; the plan gets services from a big recordkeeper; and your advice is needed now because a half-year is a short time for software and systems changes. Also, assume the proposed rule, although it does not apply for 2026, is the available Treasury interpretation, which a plan may apply regarding a participant’s tax year after 2023.

14 minutes ago, Peter Gulia said:

Soon (unless Congress changes the law, or the IRS publishes another nonenforcement)

From what I hear we are expecting final regs, not another delay.  I don't see it on the OMB Dashboard yet, so it may be a December surprise. 

RatherBeGolfing, thank you for the information about the rulemaking.

BenefitsLink neighbors, any help on whether an employer ought to prefer door number one or door number two [above]?

Regarding door number 1, are you suggesting/asking the following?: a highly paid employee is expected to receive $300,000 in eligible pay in 2026 and has a 20% percent pre-tax deferral election on file. The employer will change the deferral election to be 2.5% Roth ($7,500/$300,000) and 17.5% pre-tax as of January 1, 2026? 

If my above interpretation is accurate, then I would choose door number 2 because door number 1 is a bad idea (in my view). Problems I see with option 1 are: correctly determining expected pay, termination before year end, ensuring the Roth portion is still matched even if the plan does not match catch-up, and not correctly processing a deferral election of 20% and deeming it before any dollars are required to become Roth.

Door number 2 is preferred. I have spoken with many large employers (+1000 ee's) and for those who currently have a single deferral election process (i.e., spillover), they are going with the second option. 

For employers that currently use a separate/dual election process, it is a different story (but still not option 1). 

From the perspective of the recordkeeper, the recordkeeper needs to track what is sent to them by payroll. If payroll says pre-tax or Roth, and elective deferral or catch-up, that's what it is.  (For compliance test, there may be some amounts that get treated other than as designated by payroll, but that is not the question.)

If payroll is run where an employee only can specify one elective deferral % for pre-tax and one elective deferral for Roth, then payroll will have to track YTD deferrals and stop the pre-tax when the accumulated total elective deferrals reach the deferral limit.  

If payroll is run where a High Paid employee can specify a pre-tax elective deferral, and also a Roth elective deferral and a Roth catch up, then payroll again will have to track all the separate accumulated totals and stop the pre-tax contributions once the total elective deferrals reach the deferral limit.

There are other permutations of elections and they each have their downsides.  Administering the new provisions will be significantly more prone to errors.

The takeaway is, if there is firing squad to shoot whoever screws it up, payroll will not stand next to the recordkeeper, rather payroll will stand in front of the recordkeeper.

In my mind, option 1 is very problematic for one very simple reason.  Despite a participant making two elections (one for regular and one for catch-up) from the get-go, the amounts withheld pursuant to the catch-up election ARE NOT CATCH-UP CONTRIBUTIONS UNTIL A PLAN/REGULATORY LIMIT IS REACHED.  Consider an employee who terminates mid-year, after the employer made a "tax-election" on behalf of the participant, without considering their entire tax situation, and then it turns out that the catch-up contributions are NOT catch-ups, because a limit wasn't reached.  The employer just potentially cost the participant tax consequences unnecessarily, and "malpracticed" it at the same time.  I'm a lawyer (but not a litigator) but if a large enough employer did that, then maybe had mass layoffs costing many people money, I'd brush up on my class-action litigation skills (or referral skills) rather quickly.

As a recordkeeper, we hate all available options, but the single election with spillover seems less problematic.  That said, my recordkeeping employer uses the dual election method (and when this becomes effective, it will impact me personally.)  Frankly, I'm not going to be working long enough for the numbers of beginning Roth contributions to work, so my after-tax savings won't be in the plan....  I expect this will impact a number of those who are going to be subject to this rule....

RatherBeGolfing, thank you for the information about the rulemaking.

WCC and Paul I, thank you for sharing your helpful, smart thinking.

WCC, would any element of your reasoning change if the employer takes wage reductions for elective deferrals never as a percentage of any measure of compensation but always as a specified amount? (Some employers will continue to do that no matter what anyone resolves about restraining some participants’ choices for catch-up deferrals.) Taking deferrals as specified amounts would seem to make knowable a year’s apportionment between non-Roth and Roth deferrals. For example, if the relevant year’s limit for a 60-something, hypothetically, is $34,750, of which $23,500 may be non-Roth and $11,250 must not be non-Roth and there are 26 pay periods in the year, the employer could set a pay period’s non-Roth amount as $903.84 and the Roth amount as $432.69.

The trouble about a participant’s employment ending (or deferrals otherwise ending) before the year ends seems relatively constant with either a percentage of compensation or a specified amount as the mode for wage reductions.

I apologize for not specifying that my imaginary plan has no matching contribution.

For an employer that calls a participant to specify, distinctly, each pay period’s non-Roth and Roth amounts, could door number two work? Once a participant’s amounts deferred under her non-Roth election have filled the year’s without-catch-up limit, the amount that otherwise would be the participant’s per-pay non-Roth amount is added to her per-pay Roth amount (unless the participant elects, properly, otherwise)?

Bill Presson, § 414(v)(7) has many harmful aspects, and one might vent a little.

Paul I, I recognize that, at least initially, a recordkeeper records an amount as non-Roth or Roth following the paymaster’s instructions, which convey (one hopes) the participant’s instructions. Imagine the plan’s governing document provides that, once a § 414(v)(7)-affected participant’s non-Roth deferrals within a year have filled her without-catch-up limit, the participant’s non-Roth election is superseded and replaced with a deemed election for Roth deferrals. Could an employer/administrator and its recordkeeper agree, between them, that the recordkeeper’s service obligation is to track when non-Roth deferrals must stop? And, if the plan so provides, become Roth deferrals? With these points, could a service contract provide that the recordkeeper tells the paymaster what non-Roth and Roth deferral amounts to report on a § 414(v)(7) affected participant’s Form W-2 wage report? Or, even without a distinct information feed from the recordkeeper to the paymaster, might it be good-faith reporting for a paymaster to presume the recordkeeper performed according to its service contract?

BenefitsLink neighbors, are there other challenges I ought to think about?

MoJo, I too dislike door number one for reasons aligned with your reasons.

A related practical question:

Proposed 26 C.F.R. § 1.401(k)–1(f)(5)(iii) states: “[A] plan that satisfies the requirements of paragraph (f)(5)(iv) of this section [that an affected participant have an “effective opportunity” to make an election different than the deemed election] may provide that an employee who is subject to the requirement under [Internal Revenue Code] section 414(v)(7) to make any catch-up contributions as designated Roth contributions is deemed to have irrevocably designated any elective deferrals that are catch-up contributions as designated Roth contributions in accordance with paragraph (f)(1)(i) of this section.”

Usually, “may provide” used in a context like this refers to something that, eventually, must be stated (or omitted) by the written plan.

One presumes documenting (in what the IRS regards as “the” written plan) what a plan had provided might wait until the end of the applicable remedial-amendment period.

In theory, a plan sponsor keeps records of what provisions were put in operation so a later plan amendment or restatement can state retroactive provisions that remember how the plan was administered during the remedial-amendment period. In practice, some service providers contract or volunteer to keep these records for a plan’s sponsor/administrator. Further, even without keeping records to support a written-plan regime, many service providers keep records of a customer’s instructions to the service provider.

Is a choice about whether a plan provides or omits a deemed election about § 414(v)(7) a choice for which a recordkeeper or third-party administrator will seek its customer’s service instructions?

If so, is a plan sponsor’s choice between providing or omitting a deemed election a choice for which a recordkeeper will set its default that applies if the customer, after a notice period, has failed to specify its instruction?

Will a service provider record the plan sponsor/administrator’s choice so an assembler of the later plan amendment or restatement can use that information?

2 hours ago, Peter Gulia said:

WCC, would any element of your reasoning change if the employer takes wage reductions for elective deferrals never as a percentage of any measure of compensation but always as a specified amount? (Some employers will continue to do that no matter what anyone resolves about restraining some participants’ choices for catch-up deferrals.) Taking deferrals as specified amounts would seem to make knowable a year’s apportionment between non-Roth and Roth deferrals. For example, if the relevant year’s limit for a 60-something, hypothetically, is $34,750, of which $23,500 may be non-Roth and $11,250 must not be non-Roth and there are 26 pay periods in the year, the employer could set a pay period’s non-Roth amount as $903.84 and the Roth amount as $432.69.

No, for two reasons (1) the reason Mojo outlined above (including making sure the match formula is taking into account these early "catch-up" contributions even if the plan says it does not match catch-up) (2) is the employer going to look at every catch-up eligible employee every period (assuming employees may make deferral changes at any frequency) to determine when to prorate their deferrals? Maybe for a one person plan when this information is known, but this process is not repeatable for a company of any significant size. 

WCC, you nailed it! Thank you!

I share the opinion that allowing separate elections in payroll for elective deferrals and for catch-up contributions is a bad idea, but there are companies that use this approach and collect separate elections.  It is a reality, and as I noted, it can cause problems with compliance (which - thankfully - is not done by payroll).

It is worth exploring why a company would use the approach to make separate elections.  The scenario I have seen most often involves the plan having a relatively low maximum elective deferral percentage (more commonly applicable only to HCEs).  Catch-up contributions have universal availability and the company takes the position that a participant who defers at the maximum percentage must have the opportunity to make catch-up contributions, and so they allow a separate catch-up election.

The other scenario is where the payroll cannot or will not support tracking the annual deferral limit and automatically change from elective deferrals to catch-up contributions once the annual deferral is reached.  This seems to be more prevalent when payroll is run in-house, but there are payroll companies that say this is not their responsibility.

Not my recommendation, not my circus, not my clowns, but it happens.

In my view the only way to roll is:

Each pay-period, run the following test on a YTD basis: (using 2025 limits) 

• Have they exceeded $23,500?
  • If yes, Do Roth deferrals = or exceed $7,500?
    • If yes, deferrals = whatever the participant elected (may of course be 100% pre-tax, 50/50, etc)
    • If not, Deferrals are 100% Roth (well at least until Roth is 7,500 YTD and then whatever the standing election is.

[I will note that of course applying and reviewing calendar year-to-date limits is completely within the scope of their skill sets].

My "apply as a year-to-date limit calculation" method has a real nice side benefit: If the only reason someone's deferrals are "overridden" to Roth is based on this YTD Limit calculation (performed programmatically), their payroll deduction contributions will revert back to their standing election on the following 1/1, which in my view is an enormous consideration that is often not discussed (i.e., what happens on 1/1 after being reclassified).  This is no different than someone electing $3,000 a pay-period 1/1, having their deferrals stop when the max is reached, and then resume the following 1/1 automatically as the standing election.

I think this is a reasonable implementation of the fact that "catch-ups are the last contributions of the year."  It just seems a bazaar interpretation that someone who contributed $23,500 of Roth in the first 9 months is barred from pre-tax for Q4 because of a literalist reading of the statute that disregards any sense of practicality.  I think it is somewhat akin to capping the match at X% of the max comp amount, regardless of your YTD comp when the match is being funded.

[edited for a reversal in my bullets]

austin3515, yes this.

A plan’s sponsor/administrator wants its service provider to keep the software running continually, checking each pay period’s amounts when received to test each participant’s cumulative (YTD) deferrals and her to-be-processed deferral for whether any applicable limit would be exceeded, and to apply the plan administrator’s standing instruction—whether a deemed election, a mistaken-contribution presumption, or something else—to adjust what otherwise would exceed a limit.

Each year begins anew.

And the logic works for several kinds of limits.