It is now possible to offer plan participants in 401(k), 403(b), and 457(b) plans the option to treat employer contributions as Roth contributions, under the SECURE 2.0 Act. 
More precisely, it is Section 604 of the SECURE 2.0 Act that allows plan participants to elect to have any fully vested employer contributions funded to a defined contribution plan made as Roth for tax purposes, Alison J. Cohen, Esq., CPC, a Partner at the Ferenczy Benefits Law Center LLP, has noted.
Industry experts at the American Retirement Association offer their insights on this new benefit option, and employer benefits plan administrator Watkins Ross provides some tips.
Employers
An employer can offer this option, even if it does not offer employee Roth deferrals. But while an employer can offer this option, it is not required to—even if it does allow Roth deferrals.
Robert Richter, American Retirement Association Retirement Education Counsel, says he finds it “interesting is how many sponsors are interested in this provision, yet they’ve had the ability to do in-plan Roth rollovers (some refer to them as transfers), for years. The tax affect is similar, although in-plan Roth rollovers have a recapture provision for the early distribution 10% tax.”
Employees
Under SECURE 2.0, employees are to have the opportunity to change their Roth designations for employer contributions at least once in each plan year. “An employee generally may be permitted to designate an elective contribution as a Roth contribution without being permitted to designate a matching contribution or nonelective contribution as a Roth contribution,” says Kelsey Mayo, the American Retirement Association’s (ARA) Director of Regulatory Policy.
Employees cannot receive employer contributions unless they actively make an election to do so. If an employee does make such an election, it is irrevocable.
Participants must be fully vested in matching or nonelective contributions before they can choose to make the employer Roth designation. “For participants, the top priority is making sure they understand the tax effect of the election so that they aren’t hit with a huge tax liability for year of the Roth contribution,” says Richter.
Contributions
Employer contributions—matching or nonelective—are not compensation; however, they are includible in an employee’s taxable income.
Contributions are not subject to federal income taxes or withholding, nor are they subject to Social Security (FICA) and federal unemployment (FUTA) taxes. However, Mayo notes that for governmental 457(b) plans, the contributions may be subject to FICA unless the employees are covered by a Social Security replacement plan.
Says Richter,
“With Roth deferrals, adjustments to withholding are automatically made at a payroll level and the withholding is usually made over the course of the year. With designated Roth employer contributions, it will be up to participants to initiate any increased withholding. With a payroll-based match, withholding could be increased for every pay period. With employer contributions that are allocated on an annual basis, there will be a shorter period of time left in the year to proportionately increase withholding.”
Robert M. Kaplan, ARA Director of Technical Education, notes that employer Roth contributions must be separated from pre-tax employer contributions and from Roth deferrals. They are to be maintained in a separate designated Roth account for employer matching contributions or employer nonelective contributions. Determining the amount allocated to a participant’s account that can be designated as Roth is a key role for a third party administrator, Richter adds.
Designated Roth employer contributions will be reported in the same manner as if the contribution were directly rolled over to a designated Roth account, Mayo notes. They are reported on federal Form 1099-R for the year they are allocated to the participant’s account.
Action Steps
Richter says that the first thing to do is to make sure the plan’s recordkeeper is able to handle designated Roth contributions. Similarly, Watkins Ross suggests that plan sponsors may find it wise to confer with a payroll professional and plan recordkeeper in that vein.
Kaplan says that a key issue is when record-keeping companies will be ready to accept and track these different types of funds, and adds that major system enhancements are necessary to accomplish that. “Then they will have to find out which employers want to adopt this feature,” he adds.
An employer that decides to offer Roth employer contributions will need to draft administrative procedures for running such a program and an election form for participants, Watkins Ross suggests.
Communication and education are a priority, Kaplan argues. Employers and plan sponsors need to consider how they will implement a communication strategy about employer Roth contributions. Further, he notes that third-party administrators (TPAs) will have to educate employers as well.
Plan sponsors also may want to let participants know that they may find it useful to make adjustments to their tax and withholding elections accordingly. “Someone will have to communicate with participants about the parameters (source must be 100% vested) and tax ramifications,” says Kaplan.
“Key roles for the sponsor are ensuring participants understand the tax effects of making the Roth contribution (and this function may be handled by the service providers) and being able to quickly implement changes in withholding elections,” says Richter.
Broader Issues
“We do not think, based on a plain reading of the statute, that there is a recapture provision for the new designated employer Roth contribution,” says Richter.
He continues,
“ARA has asked the IRS for confirmation of this. The IRS provided a reasonable, and what we believe to be a correct, interpretation of the law in IRS Notice 2023-62 by providing that reporting is done on a 1099-R rather than Form W-2. This means the provision can be implemented without impacting payroll, other than implementing withholding elections.”
- Log in to post comments