Congress Expands Roth Features in Retirement Plans with SECURE 2.0 Amendments
The Rothification of 401(k) Plans: What You Need to Know
In 2001, Congress made a significant change to the Internal Revenue Code by adding section 402A, allowing 401(k) plans to include a “qualified Roth contribution program.” This allowed participants to designate their elective deferrals as Roth contributions starting in 2006. Fast forward to 2022, and Congress further expanded the use of Roth features in retirement plans, leading to what is now commonly referred to as “Rothification.”
The concept of Roth contributions was introduced in the Economic Growth and Tax Relief Reconciliation Act of 2001, offering participants the option to pay taxes on contributions in the current year but enjoy tax-free investment earnings on qualified distributions. This was a game-changer in retirement planning, providing a new tax-saving strategy for participants.
After the initial introduction of Roth contributions, plan sponsors and advisers faced the challenge of deciding whether to amend their plans to include Roth features and how to communicate the benefits to participants. Administrative procedures had to be implemented to ensure compliance with the new regulations. However, the decisions made back then were just the beginning of what was to come with the recent changes in the law.
In December 2022, Congress passed the Consolidated Appropriations Act, 2023, also known as “SECURE 2.0,” which included amendments to the IRC and ERISA provisions related to retirement plans. These changes incentivize plan sponsors to include Roth features in their plans by offering new opportunities for tax savings.
SECURE 2.0 allows defined contribution plans to include emergency savings accounts with more flexible distribution provisions, but only Roth contributions are permitted. Additionally, catch-up contributions must now be made as Roth contributions unless the participant earns less than $145,000 in the prior year. These changes encourage plan sponsors to “Rothify” their plans, as Roth contributions offer significant tax advantages for participants.
The amendments also allow participants to designate employer matching contributions and nonelective contributions as Roth contributions, expanding the tax-saving opportunities within retirement plans. Furthermore, amounts held in a participant’s Roth contribution account are now exempt from required minimum distribution rules, providing additional flexibility in retirement planning.
While these changes offer new opportunities for tax savings, they also bring complexity to plan design, compliance, and administration. Plan sponsors, advisers, and participants will need to navigate these changes carefully to maximize the benefits of Roth features in their retirement plans.
In conclusion, the “Rothification” of 401(k) plans and other retirement plans is well underway, thanks to the recent legislative changes. As plan sponsors and participants adapt to these new rules, the role of legal, financial, and other advisers will be crucial in helping them make informed decisions and navigate the complexities of the new regulations. Stay informed and seek guidance to make the most of these tax-saving opportunities in your retirement planning.
