The Secure 2.0 Act (Secure 2.0), a sweeping retirement bill included in Division T of the Consolidated Appropriations Act of 2023, was a major bipartisan accomplishment of the 117th Congress. The bill included 82 provisions to expand coverage and increase retirement savings, preserve income, and simplify or clarify retirement plan rules. But it also contained several major provisions to raise revenue in order to achieve budget neutrality over the ten-year window used by the Congressional Budget Office (CBO) to score legislation.
Section 603 of Secure 2.0
One of these revenue provisions was Section 603, which created I.R.C. Section 414(v)(7) to require that all catch-up contributions to qualified plans for participants earning over $145,000 must be subject to Roth treatment and designated on an after-tax basis. It’s important to understand that this rule applies to various types of retirement plans, such as qualified plans under section 401(a) (including 401(k) plans), 403(b) plans, and 457(b) plans. However, it does not affect SEP plans governed by Section 408(k).
“Catch-up contributions” were created through the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and allow individuals over 50 years old to make additional contributions to 401(k), 403(b), or 457 plans in defined amounts above the statutory limits. For example, the current annual limit for these plans is generally $22,500, but individuals over age 50 may elect to contribute an additional $7,500 to help them catch up in saving for retirement. The CBO estimated that Section 603 of Secure 2.0 would raise $13.2 billion over ten years by shifting forward the expected timing of taxation of the affected contributions.
The provision was scheduled to become effective January 1, 2024, but industry argued that more time was needed for firms to update employee benefits systems and accommodate separate Roth contributions to eligible participants. Additionally, some in the employee benefits community were concerned that the language of the provision was drafted so as to prohibit all catch-up contributions.
IRS Notice 2023-62 clarified that this was not the case, and addressed compliance concerns by providing high-income plan participants over age 50 a two-year “administrative transition period.” Pursuant to Section IV of the Notice, until taxable years beginning after December 31, 2025, catch-up contributions to pre-tax defined contribution plans will still be treated as satisfying the requirements of Section 414(v)(7), and more generally, plans that do not provide for Roth designated contributions will be treated as satisfying the requirements of Section 414(v)(7). This means that for the remainder 2023, 2024, and 2025, all individuals over age 50 will be able to make catch-up contributions under the current rules. This is a welcome temporary relief for many businesses who are focused on growing their business rather than updating employee benefits systems.
Impacts on Retirement Planning
To the extent that the provision is expected to take effect in 2026, it is anticipated that more high-income earners will opt for a Roth plan as they prepare to make catch-up contributions later in their careers. The Notice’s aggregation rules confirm that that ordinary retirement contributions (i.e., the first $22,500 before catch-up contributions) for these individuals can continue to be made on a pre-tax basis.
In general, deciding between a traditional 401(k) or IRA retirement plan and a Roth plan hinges primarily on one’s current individual income tax rate and expected future tax rate. However, the time until retirement and expected rate of return on the value of the deduction in the case of a traditional 401(k) also factor into the exact calculation.
Finally, it’s important to note that beginning in 2025, special additional catch-up contributions for people between the ages of 60 and 63 will also permitted. Secure 2.0, Section 109. Total permissible catch-up contributions for these individuals will be increased to the greater of $10,000 or 50 percent more than the regular catch-up amount in 2025.
KJK will continue to monitor developments related to implementation of the Secure 2.0 Act. In the meantime, if you have questions or concerns or want to learn more about how to optimize the tax efficiency of your estate, contact Estate Planning Partner Susan Friedman (SLF@kjk.com; 216.736.7272).