New Retirement Catch-Up Rules Pose Challenges for Plan Sponsors
The IRS’s recent proposed regulations on automatic enrollment, Roth catch-up contributions, and super catch-up contributions under SECURE 2.0 provide some clarity, but they introduce challenges for retirement plan sponsors.
Issuing the regulations just weeks before the change of presidential administrations may delay implementation or affect employers’ timelines and planning efforts. Still, sponsors should document and communicate all plan changes to ensure accurate administration and fulfill fiduciary duties to plan participants.
Automatic enrollment is mandatory for most plans established after SECURE 2.0’s enactment. New plans that don’t qualify for an exception will have less flexibility in design going forward. Prior to this requirement, many plans didn’t include automatic enrollment because of additional costs such as higher matching contributions or issues from employees who didn’t want deferrals made from their pay.
Plans that did offer automatic enrollment wouldn’t always include automatic escalation for similar reasons, but also to simplify plan and payroll operations. In fact, some recordkeepers are suggesting that plans start at a 10% contribution rate to avoid having to administer the automatic-escalation requirement.
Although administrative, audit, and recordkeeping costs likely will increase for plans subject to mandatory auto-enrollment and auto-escalation provisions, plan participants typically bear these costs. Plan sponsors may want to consider and compare that with the costs of other retirement programs that may be available to their workforce, including multiple employer and pooled employer plans, as well as any stated-mandated individual retirement account program.
Automatic enrollment features increase the risk of error when implementing deferrals because more employees becoming plan participants increases the likelihood of mistakes in implementation, as well as affirmative elections to make higher or lower contributions.
The IRS historically has offered less punitive correction programs for such errors, but it’s uncertain whether these options will continue once the correction procedures are updated under SECURE 2.0. Plan sponsors should pay close attention to how these features are implemented to ensure accuracy.
The proposed rules for Roth (post-tax) catch-up contributions that apply to high earners also pose challenges for plan sponsors. Payroll system programming of catch-up contributions levels, which are based on age, has been a primary problem.
Determining wages greater than the $145,000 threshold for purposes of the Roth catch-up contribution requirement involves numerous rules, necessitating precise tracking and recordkeeping. Plans haven’t used this limit historically, so it will require new payroll programming and coordination.
Distinguishing between highly paid individuals for Roth catch-ups and highly compensated employees for most other plan purposes—which are subject to different limits and rules—is likely to cause confusion and errors, both from a participant and operations perspective.
Implementing Roth catch-up contributions also introduces complexity into participant disclosures. For example, highly paid individuals may elect to make Roth deferrals, rather than pre-tax deferrals, before reaching the catch-up limit. Those deferrals can count toward the Roth catch-up requirement, enabling them to switch to regular pre-tax deferrals later in the year if desired (and permitted by the plan). Employers must clearly communicate with and provide administrative support to employees so they can understand how to implement this strategy.
If catch-up contributions are mistakenly contributed as pre-tax, employers can correct errors if they’re quickly identified. Plan sponsors should develop procedures to periodically review deferrals for highly paid individuals to avoid costly corrections.
The proposed IRS rules also include guidance on super catch-up contributions, which many plan sponsors opted not to adopt for 2025. This optional change has already proven challenging to implement.
Plans that reference Section 414(v) generally will automatically permit super catch-up contributions unless the plans were amended by Jan. 1, 2025. Accordingly, some plan sponsors have discovered that their plan documents permit super catch-ups, but their payroll systems aren’t equipped to support them.
Retroactive amendments would remove an eligible participant’s right to make super catch-up contributions and arguably would require filing through the IRS’s Voluntary Compliance Resolution program, in which obtaining IRS approval generally takes months and requires paying filing fees, unlike self-correction.
For both Roth catch-ups and super-catch-up elections, plan sponsors should consider the impact of making changes on all other retirement savings elections—including any nonqualified deferred compensation elections—to avoid violating tax code Section 409A, which may trigger immediate income taxation and penalties.
For example, plan sponsors should consider whether corresponding amendments to any so-called linked plans are appropriate, given the changes to the underlying 401(k) plan contribution formulas. Violating the rules can lead to an additional 20% income tax, acceleration of income recognition, and imposition of interest penalties under tax code Section 409A.
The IRS delayed the mandatory amendment deadline until the end of 2026 for most plans. Plan sponsors that delay addressing implementation issues may struggle to get their plan providers’ attention.
A thorough SECURE 2.0 amendment for mandatory items alone can be several pages long, leaving plan sponsors with the added challenge of administering a complex plan document that has several lengthy plan amendments. Sponsors may want to prepare a restated plan incorporating all interim and discretionary amendments to improve plan administration accuracy and communication with plan participants.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Author Information
Stephanie A. Smithey co-chairs Ogletree Deakins’ employee benefits and executive compensation practice group.
Carly E. Grey is shareholder at Ogletree Deakins in Washington, D.C., with focus on employee benefit and executive compensation matters.
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