Author | Bonnie Treichel
The term “Rothification” has been around Capitol Hill for a long time. Given that Congress works in 10-year budget cycles, it is a way to raise revenue when Congress is trying to save with other measures. SECURE 2.0 was no different; here’s what you need to know about Roth from SECURE 2.0 and subsequent guidance from the Internal Revenue Service (IRS) impacting changes to Roth.
Here’s What You Really Need to Know:
- Roth features are not for everyone, but they are an additional tool that can benefit many participants.
- Roth features continue to be a focus in major legislative initiatives because it is a way for the government to raise money given that traditional contributions, on the other hand, reduce the immediate tax revenue to the government.
- Many service providers do not yet have all of the new Roth features from SECURE 2.0 and subsequent guidance available on their recordkeeping and/or payroll platforms, but those features are becoming available as the months progress.
Let’s Dive In…
Refresher on the Basics
A traditional contribution to a qualified retirement plan is made on a pre-tax basis, but participants pay income taxes once that money is distributed from the retirement plan. A Roth contribution, on the other hand, is a contribution that is made with after-tax money that a participant can withdraw tax-free once they reach the age of retirement. This should not be confused with an individual retirement account (IRA). Often, the concept of Roth is associated solely with IRAs, but Roth is a contribution type in a qualified retirement plan such as a 401(k) or a 403(b) plan so long as the plan document allows for this type of contribution. It should also be noted that Roth is different than an after-tax contribution (though they are both made with after-tax dollars).
Recent Roth Legislation
SECURE 2.0 passed at the end of 2022 and included several provisions related to Roth. And just like all massive legislation, there were several other pieces of guidance from the IRS following SECURE 2.0. Three primary provisions that may require the attention of plan sponsors (or their participants) in 2024 and beyond:
- Roth Catch-up Provision: Section 603 provides that all catch-up contributions to qualified retirement plans are subject to Roth tax treatment, except for employees with compensation of $145,000 or less (indexed for inflation). In August 2023, the IRS issued guidance that moved the implementation date from January 1, 2024 to January 1, 2026. This provision is mandatory.
- Roth Employer Contribution: Section 604 allows qualified plans to amend their plan document such that participants, if they so elect, may receive their matching or nonelective contributions as Roth. Although this optional provision became effective immediately after enactment of SECURE 2.0, it was not largely adopted by plans because additional guidance was required by the IRS. On December 20, 2023, the IRS issued Notice 2024-02 which included important tips on how to handle Roth contributions. A few take-aways from the guidance:
- Employees must have the opportunity to change their Roth designation at least once per year.
- A designated Roth contribution (matching or nonelective) is included for the taxable year in which it is allocated, and the reporting of the employer Roth contribution would be on a 1099-R for the year in which the contributions are allocated to the participant’s account.
- Rollovers from 529 Plans: Starting in 2024, Section 126 allows for tax-free and penalty-free rollovers from 529 accounts to Roth IRAs so long as certain conditions are met. If too much is contributed to a 529 plan or if the 529 plan is not used by a beneficiary, then that money can be rolled into a Roth IRA (up to $35,000) so long as the 529 account was open for at least 15 years.
Practical Perspectives on Roth
What’s the big deal about Roth and why should plan sponsors care? SECURE 2.0 along with other recent regulatory initiatives such as the Department of Labor (DOL) Retirement Security Rule: Definition of an Investment Advice Fiduciary (also known as the fiduciary rule) are opportunities for plan sponsors to re-evaluate their overall financial education and experience for participants.
Changes such as the change for 529 plans do not require any change by plan sponsors to their qualified plans; however, as plan sponsors consider the overall employee education program, it is important to consider all of the updates that impact Roth in qualified plans, as well as outside of the plan, including 529 plans and IRAs. Plan sponsors should also consider their plan documents and ensure that Roth is an available option if the plan’s needs so require. For example, until recently several plans still didn’t have employee Roth contributions as an option. However, with the many recent changes, Roth as a contribution option is more prevalent in retirement plans.
The benefits of Roth vary across participants and are individualized; however, in general, Roth is typically beneficial for those individuals that anticipate they will be in a higher tax bracket in the future. This allows the individual to pay the taxes now while at a lower tax rate and avoid paying taxes later when at a higher tax bracket/rate and withdrawing funds. Plans that include a greater number of participants with a younger demographic may want to consider the impact of a Roth option in their plan.
Action Items for Plan Sponsors
In general, these changes are not required provisions for plan sponsors, but rather, changes related to Roth are levers that plan sponsors and participants can pull. While plan sponsors may always want to consider meeting basic needs of the plan first (for example, compliance and minimum savings rates), they should also consider the following to better prepare their participants for retirement and financial success:
- Evaluate participants’ demographics and savings trends to identify areas where additional opportunities, such as adding the employer Roth option, may be included.
- Review the plan document to determine if there are opportunities for amendments based on the needs of the plan and its participants.
- Discuss potential enhancements and limitations at service providers based on the recordkeeping system. Where there are limitations, continue to monitor (and consider what third party tools can help monitor) as there are continually changes and updates to what is available with the constantly evolving regulatory and legislative landscape.
