In the SECURE 2.0 Act of 2022 there’s now an option plan sponsors can add allowing participants to elect to receive employer matching and nonelective contributions as Roth contributions. While initially expected to follow the same process as employee Roth contributions, recent IRS guidance reveals a different tax treatment for employer contributions, prompting considerations for implementation and potential tax impacts for employees.
Interest is building from employers about the Roth expansion provisions in the SECURE 2.0 Act of 2022 (SECURE 2.0). In particular, the optional provision that allows participants the ability to make an election to receive all or a portion of their future employer matching and nonelective contributions as Roth contributions.
Participants with both pre-tax contributions and Roth have account balances that are 43% higher compared to those with no Roth contributions.
It was originally thought the implementation of the provision would mirror the current Roth election process for employee contributions. However, subsequent IRS guidance shows the department took a different approach for employer Roth contributions, specifically regarding their tax treatment.
Tax treatment differences:
| Designating employee contributions as Roth contributions | Designating employer matching and nonelective contributions as Roth contributions |
|---|---|
| The contribution amount is included in the employee’s gross income for that pay period. | The contribution amount is included as gross income for the taxable year and reported on Form 1099-R. |
| The amount is subject to all applicable wage-withholding requirements via the payroll system. | Payroll taxes are not withheld (FICA and FUTA) |
Because payroll taxes will not be withheld for employer Roth contributions received after employees make an election, employees may want to adjust their W4 withholding to counter a potentially higher tax bill at the end of the year. Even if a provider’s forms or website offer a warning at the time of election, it’s quite possible that an employee could forget to adjust their withholding and be faced with a surprise tax bill at the end of the year. After all, they don’t have to worry about withholding adjustments when electing Roth for their employee contributions.
Implementing employer Roth contributions
This optional SECURE 2.0 provision has been available since 2023, but implementation was delayed while plan service providers waited on IRS clarification about the tax treatment. Since additional details have been published, some service providers are now starting to build out the necessary system capabilities to enable implementation.
Alternative – Roth in-plan conversion
For plan sponsors contemplating if this provision is right for their plan or participants, there’s some good news: an alternative is already available. This option may be easier to implement and could help avoid employee dissatisfaction.
An in-plan Roth conversion allows participants to transfer a part or all pre-tax retirement money to Roth. The pre-tax retirement money can include both employee and employer contributions.
Participant benefits:
- Employees can choose which contributions (employee or employer) and how much to convert to Roth.
- The tax impact is clearer as it can be estimated at the time of the conversion. This should reduce the chance of unexpected tax bills at tax time.
Employer benefits:
- No changes to the plan are needed if the plan already offers a Roth account. Currently 76% of plans offer Roth contributions to participants.
- In-plan Roth conversion is available to all employees (Roth election for employer contributions is only available to non-highly compensated employees).
Whether to implement employer Roth contributions or opt for an in-plan Roth conversion, it's important to weigh the benefits and challenges of each option. As always, it's advisable for plan sponsors to consult with their service providers and tax professionals to determine the best course of action for their specific needs and goals.
What’s next for SECURE 2.0?
Employers have continued to actively incorporate the required and optional provisions of SECURE 2.0 provisions to their retirement plans as effective dates approach. Given the complexity of this extensive legislation, many still have questions. To help you, we’ve compiled a trending questions and answers document about the SECURE 2.0 and what it can mean for employers.
