The SECURE Act 2.0: The Most Impactful Provisions (#4–Optional Treatment of Employer Contributions as Roth Contributions)

Key Takeaways

  • The SECURE Act 2.0 permits plan sponsors to give participants the option of receiving employer contributions on a Roth basis.
  • This provision is effective on the date of enactment, December 29, 2022.
  • However, the option may not be as attractive as it first appears, since the matching and nonelective contributions must be fully vested when made.

The President signed the Consolidated Appropriations Act, which included SECURE Act 2.0, on December 29, 2022.

SECURE Act 2.0 has over 90 provisions, some major and some minor; some mandatory and some optional; some retroactively effective and some that won’t be effective for years to come. One difference between the SECURE Act 2.0 and previous acts is that so many of 2.0’s provisions are optional…that is, plan sponsors are not required to adopt the provisions, but can if they conclude that the change will help the plan and the participants. This series discusses the provisions that are likely to be the most impactful, either as options or as required changes.

This article discusses one of the optional provisions—the ability of plan sponsors to permit participants to elect to receive matching and nonelective employer contributions on a Roth basis, meaning that the contributions would be taxed through to the participant when made, but that the contributed amounts would ultimately be distributed tax free and, if the Roth conditions are satisfied, the earnings would also be tax free. This provision was effective on the date on enactment of SECURE Act 2.0—December 29, 2022.

As a result, if a plan sponsor decides that this opportunity would be attractive to its participants, it can allow the participants to elect whether or not to “Roth” the employer contributions. Based on the wording of the amended Internal Revenue Code provision, it appears that the election can be for matching contributions, nonelective contributions, or both.

However, there is an important limitation—the plan sponsor must fully vest the matching or nonelective contributions.

With regard to matching contributions, the amendment says that Roth treatment is available, “but only if such contribution is nonforfeitable at the time received.”

With regard to nonelective contributions, the amended Code provision says: “Any designated Roth contribution which pursuant to the program is made by the employer on the employee’s behalf and which is a nonelective contribution shall be nonforfeitable and shall not be excludable from gross income.”

That requirement will likely reduce the attractiveness of Roth employer contributions since many plans using vesting schedules.

However, that requirement makes sense. Roth treatment means that an employee pays taxes on the match or nonelective contribution. A scenario in which an employee paid taxes on a contribution and later forfeited part of the contribution when the participant moved to another job would result in employees being taxed on money that they never received.

Another approach would be for the IRS or Congress to clarify that the Roth treatment would only apply to the vested portions of any employer contributions and that the Roth treatment would thereafter apply as a participant vested in the balance of the contributions. However, that presents its own administrative complexities.

For the moment, advisors and providers should educate plan sponsors about this new opportunity, while also alerting them to its limited application to plans that fully vest matching and/or nonelective contributions.

Concluding Thoughts

This optional provision will likely be the most popular with plan sponsors who employ young well-paid and well-educated workers. Roth works the best where the participants are in their lower income years and expect higher compensation in the future…and to be in a relatively high tax bracket in retirement. The ability to use Roth for company contributions would be a meaningful tax opportunity for them.

However, adding Roth features to a plan creates additional educational issues to help participants make informed decisions about whether the option is right for them. With that complexity comes opportunity, but the value of the opportunity is in making informed decisions.

The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Faegre Drinker.