On December 20, 2023, the IRS released Notice 2024-2
which provides additional guidance on a wide variety of new retirement plan rules from the SECURE 2.0 Act.
The IRS authors make clear that the purpose of the notice is to “provide guidance on discreet issues to assist in commencing implementation of these provisions” not to provide comprehensive guidance.
There are twelve topics covered by this notice, but section 604 on employer Roth contributions is of particular interest to small business owners. This section offers plan sponsors guidance on how to report and handle employer Roth contributions.
Prior to Secure 2.0 Act, only employee deferrals could have a Roth election, and all employer contributions were pre-tax traditional contributions.
After Secure 2.0, a Roth election was allowable for employer contributions for an IRS standpoint. However, before this election can actually be made, plan documents must be amended to allow it. And before plan documents can be amended to allow it, record keepers and custodians need to know the minute details of what reporting and accounting requirements are expected from this new deferral type.
While it will take some time before any plans will be ready for their first employer Roth elections, this new notice has offered beginning guidance for plan professionals. Now, record keepers and custodians can begin creating support for employer Roth contributions, so it might be a good time to ask your 401(k) provider if they can work to add this feature. For the retirement plans that we help manage, we are starting this conversation with our providers.
Summary of Information from Q&As
For those who are interested in the minute details revealed by this notice, here is my summary of the interesting points from the Q&As:
- Employer Roth contributions are included in gross income for the tax year. (L-2)
- An employee can only designate contributions to be Roth if they are “fully vested… at the time the contribution is allocated to the employee’s account.” (L-3)
- Plans which have vesting schedules can limit this Roth election to only employees who are fully vested at the time. (L-4)
- Employer Roth contributions are not included in wages, not subject to FICA taxes, not subject to FUTA taxes, and not subject to tax withholding for most plans (L-5 & L-6), but some eligible governmental plans have different rules. (L-7 & L-8)
- Employer contributions of any kind are still not considered as employee’s wages for the purpose of safe harbor calculations. (L-10)
- Plan sponsors can pick and choose which types of contributions are allowed to be Roth. There is no requirement that all options have a Roth election. (L-11)
- Employer Roth contribution balances are eligible for rollover directly to Roth IRAs. (L-11)
This means that employees who make a Roth election for some or all employer contributions may need estimated tax payments or increased withholding in order to avoid under-withholding penalties.
Full Text of Q&As
If you’d like to read them in full, here are the relevant Q&As from the notice:
A. L-1: Yes. Rules similar to the rules for designated Roth elective contributions under § 1.401(k)-1(f) (other than § 1.401(k)-1(f)(4)(i) and (6)) apply to designated Roth matching contributions and designated Roth nonelective contributions. For example, similar to the rules under § 1.401(k)-1(f)(1) that apply to designated Roth elective contributions: (1) any designation of a matching contribution or nonelective contribution as a Roth contribution must be made by the employee no later than the time that the contribution is allocated to the employee’s account and must be irrevocable, and (2) designated Roth matching contributions and designated Roth nonelective contributions are subject to inclusion treatment and separate accounting rules. In addition, to the extent a plan permits an employee to designate matching contributions or nonelective contributions as Roth contributions, an employee must have an effective opportunity to make (or change) that designation at least once during each plan year.
A. L-2: A designated Roth matching contribution or designated Roth nonelective contribution is includible in an individual’s gross income for the taxable year in which the contribution is allocated to the individual’s account. The preceding sentence applies even if the designated Roth matching contribution or designated Roth nonelective contribution is deemed to have been made on the last day of the prior taxable year of the employer under section 404(a)(6) of the Code.
A. L-3: No. Under section 402A(f)(3), a matching contribution may be designated as a Roth contribution only if the employee is fully vested in matching contributions at the time the contribution is allocated to the employee’s account. Similarly, under section 402A(a)(3), a nonelective contribution may be designated as a Roth contribution only if the employee is fully vested in nonelective contributions at the time the contribution is allocated to the employee’s account. For example, if at the time a matching contribution is allocated to the employee’s account, the employee is only partially vested in the portion of the employee’s account balance attributable to matching contributions, then the employee may not designate any part of that matching contribution as a Roth contribution.
A. L-4: Under § 1.401(a)(4)-4(e)(3)(i), the term “other right or feature” generally means any right or feature applicable to employees under the plan, except as provided in § 1.401(a)(4)-4(e)(3)(ii). Because there is no applicable exception under § 1.401(a)(4)-4(e)(3)(ii), an employee’s right under a plan to designate a matching contribution or nonelective contribution that may otherwise be made on the employee’s behalf under the plan as a Roth contribution is an “other right or feature” for purposes of § 1.401(a)(4)-4(e)(3). However, pursuant to the authority in § 1.401(a)(4)-1(d) to issue additional guidance that is necessary or appropriate in applying the nondiscrimination requirements of section 401(a)(4) of the Code, a plan will not be treated as failing to satisfy section 401(a)(4) merely because the plan provides that an employee may designate a matching contribution or nonelective contribution as a Roth contribution only if the employee is fully vested in that type of contribution at the time the contribution is allocated to the employee’s account (even if the right to make that designation is not currently available to a group of employees that would satisfy section 410(b) without regard to the average benefit percentage test of § 1.410(b)-5)).
A. L-5: No. Matching contributions and nonelective contributions that are made to a qualified plan under section 401(a) (including a section 401(k) plan), a section 403(b) plan, or an eligible governmental plan are excluded from wages under section 3401(a). Similarly, designated Roth matching contributions and designated Roth nonelective contributions that are made to a qualified plan under section 401(a), a section 403(b) plan, or an eligible governmental plan are excluded from wages under section 3401(a). Accordingly, designated Roth matching contributions and designated Roth nonelective contributions are not wages, as defined in section 3401(a), for purposes of federal income tax withholding under section 3402. However, an employee who designates a matching contribution or nonelective contribution as a Roth contribution may need to increase the employee’s withholding or make estimated tax payments to avoid an underpayment penalty.
A. L-6: No. Matching contributions and nonelective contributions that are contributed to a qualified plan under section 401(a) or to a section 403(b) plan are excluded from wages under section 3121(a)(5)(A) and (D). Similarly, designated Roth matching contributions and designated Roth nonelective contributions that are contributed to a qualified plan under section 401(a) or to a section 403(b) plan are excluded from wages under section 3121(a)(5)(A) and (D) (and those contributions are not added back to wages under section 3121(v)(1)(A)). Accordingly, those contributions are not wages, as defined in section 3121(a), for purposes of FICA. Matching and nonelective contributions that are contributed to a qualified plan under section 401(a) or to a section 403(b) plan also are excluded from wages under section 3306(b)(5)(A) and (D). Similarly, designated Roth matching contributions and designated Roth nonelective contributions that are contributed to a qualified plan under section 401(a) or to a section 403(b) plan are excluded from wages under section 3306(b)(5)(A) and (D). Accordingly, those contributions are not wages, as defined in section 3306(b), for purposes of FUTA.
A. L-7: Section 3121(a) defines wages as all remuneration for employment, unless specifically excluded. Section 3121(v)(2) includes special timing rules that apply in determining when amounts deferred under an eligible governmental plan (including employers’ contributions) are required to be taken into account. Under these sections, an amount deferred under an eligible governmental plan is required to be taken into account for purposes of social security and Medicare taxes as of the later of when the services are performed or when there is no substantial risk of forfeiture of the rights to such amount. Because designated Roth nonelective contributions that are contributed to an eligible governmental plan (including amounts that would be treated as matching contributions under section 401(m) if the plan were a qualified plan) must be fully vested at the time the contribution is allocated to a participant’s account, these contributions are subject to social security and Medicare taxes at that time. However, FICA tax applies to employees of state and local governments only if they are subject to social security or Medicare tax under section 3121(b)(7)(E) (relating to agreements entered into pursuant to section 218 of the Social Security Act) or another provision of the Code, such as section 3121(b)(7)(F) (relating to state and local government employees who are not members of a state or local retirement system), or section 3121(u) (relating to Medicare). See also Notice 2003-20, 2003-1 CB 894.
A. L-8: Section 3306(c)(7) generally provides a FUTA exemption for service performed in the employ of a state or any political subdivision thereof or any instrumentality of any one or more of the foregoing. In accordance with this provision, designated Roth nonelective contributions that are contributed to an eligible governmental plan (including amounts that would be treated as matching contributions under section 401(m) if the plan were a qualified plan) are excluded from wages under section 3306(c)(7). Accordingly, those contributions are not wages, as defined in section 3306(b), for purposes of FUTA. See also Notice 2003-20.
A. L-9: The reporting obligations that apply to a designated Roth matching contribution or designated Roth nonelective contribution are the same as if: (1) the contribution had been the only contribution made to an individual’s account under the plan, and (2) the contribution, upon allocation to that account, had been directly rolled over to a designated Roth account in the plan as an in-plan Roth rollover. Thus, designated Roth matching contributions and designated Roth nonelective contributions to a qualified plan under section 401(a) or to a section 403(b) plan must be reported using Form 1099-R for the year in which the contributions are allocated to the individual’s account. The total amount of designated Roth matching contributions and designated Roth nonelective contributions that are allocated in that year are reported in boxes 1 and 2a of Form 1099-R, and code “G” is used in box 7. The same reporting applies to designated Roth nonelective contributions that are contributed to an eligible governmental plan (including amounts that would be treated as matching contributions under section 401(m) if the plan were a qualified plan).
A. L-10: No. In general, the safe harbor definition of compensation under § 1.415(c)-2(d)(3) includes wages within the meaning of section 3401(a) of the Code (for purposes of income tax withholding at the source), plus amounts that would be included in wages but for an election under section 125(a), 132(f)(4), 402(e)(3), 402(h)(1)(B), 402(k), or 457(b). However, as described in Q&A L-5 of this notice, designated Roth matching contributions and designated Roth nonelective contributions are not included in wages within the meaning of section 3401(a) (nor would those contributions have been included in wages but for an election to have those contributions made as Roth contributions) Similarly, the safe harbor definition of compensation under § 1.415(c)-2(d)(4) generally includes amounts that are compensation under § 1.415(c)-2(d)(3), plus all other payments of compensation to an employee by his employer (in the course of the employer’s trade or business) for which the employer is required to furnish the employee a written statement under sections 6041(d), 6051(a)(3), and 6052 of the Code. However, designated Roth matching contributions and designated Roth nonelective contributions are not payments of compensation to an employee by his employer for which the employer is required to furnish the employee a written statement under sections 6041(d), 6051(a)(3), and 6052.
A. L-11: Pursuant to section 402A(b)(1), a qualified Roth contribution program may, but is not required, to include every type of designated Roth contribution. Thus, 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. Similarly, an employee generally may be permitted to designate a matching contribution or nonelective contribution (or both) as a Roth contribution without being permitted to designate an elective contribution as a Roth contribution. However, the right to make designated Roth contributions is a right or feature subject to the requirements of section 401(a)(4). See § 1.401(k)-1(a)(4)(iv)(B) and Q&A L-4 of this notice. Further, under sections 402(c)(8)(B) and 402A(c)(3)(A) of the Code, if any portion of an eligible rollover distribution is attributable to payments or distributions from a designated Roth account (as defined in section 402A), that portion is permitted to be rolled over only to another designated Roth account or to a Roth IRA. For purposes of sections 402(c)(8)(B) and 402A(c)(3)(A), the term “designated Roth account” includes a separate account that is established for designated Roth matching contributions or designated Roth nonelective contributions. Similarly, section 402A(c)(4)(B) requires an applicable retirement plan to include a qualified Roth contribution program in order for the plan to permit employees to make in-plan Roth rollovers. For purposes of section 402A(c)(4)(B), a qualified Roth contribution program includes a program under which an employee may designate a matching contribution or nonelective contribution as a Roth contribution, even if the employee is not permitted to designate an elective contribution as a Roth contribution.
Topics Covered by Notice
For those interested in the other topics covered by this notice, the contents are:
- section 101 (expanding automatic enrollment in retirement plans),
- section 102 (modification of credit for small employer pension plan startup costs),
- section 112 (military spouse retirement plan eligibility credit for small employers),
- section 113 (small immediate financial incentives for contributing to a plan),
- section 117 (contribution limit for SIMPLE plans),
- section 326 (exception to the additional tax on early distributions from qualified plans for individuals with a terminal illness),
- section 332 (employers allowed to replace SIMPLE retirement accounts with safe harbor 401(k) plans during a year),
- section 348 (cash balance),
- section 350 (safe harbor for correction of employee elective deferral failures),
- section 501 (provisions relating to plan amendments),
- section 601 (SIMPLE and SEP Roth IRAs), and
- section 604 (optional treatment of employer contributions or nonelective contributions as Roth contributions).
Photo by Anastasiia Romanska on Unsplash. Image has been cropped.
