IRS catch-up guidance a relief to 401(k) sponsors, advisors

Plans now have until 2026 to add Roth accounts that will allow high earners to make catch-up contributions.

The retirement plan world is breathing a sigh of relief after the IRS Friday announced a two-year delay on requiring high-income workers who make 401(k) catch-up contributions to do so in Roth accounts.

For months, plan sponsors had worried about a provision of the SECURE 2.0 Act slated to go into effect on Jan. 1, 2024, that will require the use of Roth 401(k) accounts for people with income of $145,000 or more who are 50 or older and thus eligible for catch-ups.

The problem: After-tax Roth 401(k) options today are uncommon — and adding that plan feature isn’t a matter of flipping a switch.

“The first hurdle was that many plans don’t have Roth options,” said Hailey Fields, a principal at retirement plan consultant Multnomah Group. “Those high-income earners essentially won’t have been able to make catch-up contributions, which was problematic.”

Because it’s easy for high-income workers to max out their pretax contributions before the end of a year, employers often use catch-ups for “spillover of regular contributions,” Fields said.

That system is simple, and adding the need to switch to Roth will complicate things, she said. “When you, on the exact penny, need to move a regular contribution into a catch-up contribution, you [will] need to have regular pretax and Roth in that payroll.”

Currently, the traditional pretax contribution limit is $22,500 annually, though catch-ups increase that by $7,500.

Another advisor, Kaci Skidgel, president of Summit Financial Group, had been preparing retirement plan clients for the 2024 deadline up until the IRS announcement late last week.

“It really was a race to the finish line,” Skidgel said. “Many of them were concerned that they couldn’t get it done … My clients are going to be very relieved.”

Among the topics her firm covers in presentations for clients around SECURE 2.0 provisions, the Roth catch-up mandate is one that gets a lot of questions, she said.

The change outlined in SECURE 2.0 for catch-ups in Roth accounts was necessary to help pay for some of the legislation’s tax perks, such as those that encourage startup 401(k)s for smaller employers, Skidgel noted. The tax revenue the federal government will receive from Roth vs. traditional catch-ups shifts money into the 10-year window it uses for planning.

Nonetheless, the Roth requirement is challenging for some employers because of payroll system limitations, and it could most heavily impact small businesses — particularly those with single-employee plans, Skidgel said.

One major retirement plan provider, Empower, issued a statement praising the IRS for the delay.

“Their action will help ensure an orderly implementation process and address concerns raised by plan sponsors,” chief operating officer Rich Linton said in the statement.

The news will be welcomed by employers, and particularly their HR departments, which had been worried about timely implementation. Some had concerns that if they could not meet the deadline, senior-level employees who make catch-ups would be unhappy, Fields said.

To ensure that doesn’t happen, she recommended that plan sponsors don’t drop the ball.

“Two years is more time to get Roth into the plan and educate employees that this change is happening, but it still is going to be a heavy lift,” Fields said. “We can’t just forget about this until 2025. We need to continue working on it through the rest of this year and into 2024.”

However, plans should not yet make Roth catch-ups mandatory, she said. “They should still allow their employees to make pretax [catch-up] contributions” until 2026, Fields said.

In the guidance, the IRS also clarified an error in the Secure 2.0 legislation that had been read as potentially preventing any 401(k) participants from making catch-up contributions. Catch-ups are allowed, regardless of the error, the agency noted.