On August 25, 2023, the Internal Revenue Service (IRS) announced in IRS Notice 2023-62 an administrative transition period that extends until 2026 the new requirement outlined in SECURE Act 2.0 that any 401(k) catch-up contributions made by higher‑income participants over the age of 50 must be designated as after-tax Roth contributions. In addition, the IRS confirmed that Solo 401(k) plan participants who are age 50 and over can continue to make catch‑up contributions after 2023, regardless of income.
- One of the key provisions in SECURE Act 2.0 was forcing catch-up contributions by high income earners to be made in Roth
- A recent IRS ruling has pushed that back until at least 2026
- More guidance should be forthcoming over the next couple of years
SECURE Act 2.0 – Roth Catch-Up Contribution Rule
SECURE Act 2.0 was signed into law by President Biden in December 2022. Over 90 retirement-related provisions, which became known as “SECURE 2.0” were included in the 4000+ page, $1.7 trillion spending bill — which would fund the government for the 2023 fiscal year.
Before the Act, catch-up contributions made to a 401(k) plan could be made in pretax or Roth. For example, in 2023 if one is at least age 50, he or she can make a catch-up contribution of $7,500 in pretax or Roth, irrespective of their income level. Therefore, if one is under 50, the maximum employee deferral contribution for 2023 is $22,500, but $30,000 if age 50 or above.
Under SECURE Act 2.0, 401(k) plan participants who have reached the age of 50 whose prior calendar year FICA wages from the employer exceeded $145,000 (indexed) would be required to make the 401(k) plan catch-up contribution in Roth. Whereas any 401(k) plan participant who earned less than $145,000, adjusted for inflation, would be permitted to choose the tax treatment of the catch-up contribution.
In sum, the new rule outlined in the Act required high-income earners to make their catch-up contributions in Roth. In addition, a 5 %-owner who earned less than $145,000 would still be permitted to make a pretax catch-up contribution. A catch-up contribution made in Roth would start the five-year Roth clock which is needed to trigger a tax-free Roth distribution (in conjunction with the 401(k)-plan participant being over the age of 59 1/2).
It appears that this provision intended to limit the ability of high-income earners to generate additional tax deductions in a taxable year. The House Ways & Means Committee, in conjunction with the Senate Finance Committee, needed a rule that would not reduce the amount of tax collected and this is what this provision does. By forcing high-income earners to make their catch-up contributions in Roth, they are limiting their ability to generate pretax deductions.
New Catch-Up Contribution Roth Rule & Solo 401(k) Plans
A Solo 401(k) plan is essentially a 401(k) plan for a business with no full-time employees other than the owners or their spouses. A full-time employee is defined as any employee who works more than 1,000 hours during the year or three consecutive years of 500 hours or more. The plan can be set up by any business, including a sole proprietorship.
The SECURE Act 2.0 catch-up contribution rule arguably excludes self-employed individuals because they do not pay any FICA wages. FICA, short for Federal Insurance Contributions Act, is a federal law that requires employers to withhold and remit a certain percentage of an employee’s earnings to help fund Social Security and Medicare. FICA taxes are a combination of Social Security and Medicare taxes that equal 15.3% of your earnings. You are responsible for half of the total bill (7.65%), which includes a 6.2% Social Security tax and 1.45% Medicare tax on your earnings.
FICA does not apply to the self-employed so the belief is that the requirement that catch-up contributions be made in Roth for high-income earners would not apply. Whereas the provision would seemingly apply in the case of a corporation that has established a Solo 401(k) plan for an owner who receives a W-2. The announcement included in IRS Notice 2023-62 would push the Roth requirement for high-income earners until at least 2026.
The IRS’s decision to delay the requirement to require high-income earners at least age 50 to make 401(k) catch-up contributions in Roth until 2026 was met with great support from the 401(k) professional community. Many 401(k) plans do not even have Roth components included with their plan, so the requirement was proving to be a large burden and cost for some employers. The IRS plans to issue future guidance to help taxpayers on this topic in the coming years and we will have to wait and see what, if any, changes the IRS will make concerning the catch-up contribution Roth rule.