Employee Benefits & Executive Compensation Advisory | IRS Proposes Changes to 401(k) Catch-Up Contributions

In January 2025, the Internal Revenue Service (IRS) issued proposed regulations on two issues regarding “catch-up” contributions under the SECURE 2.0 Act of 2022. 

Catch-Up Contributions

Under Section 414(v) of the Internal Revenue Code of 1986, as amended, participants who would be at least age 50 by the end of the taxable year are eligible to make additional elective deferrals, called catch-up contributions, under plans subject to Code Sections 401(k), 403(b), 457(b), as well as SEP arrangements and SIMPLE IRAs. This advisory addresses rules only for the 401(k) plans, and any reference to a “plan” means a 401(k) plan. 

Pre-Tax vs. Roth

All elective deferrals, including catch-up contributions, can be made on a pre-tax basis or on a Roth basis. Pre-tax elective deferrals reduce the participant’s taxable income in the year of the contribution; however, the participant includes in gross income any distributions of pre-tax accounts in the year in which he or she receives a distribution of those deferrals. On the other hand, Roth contributions do not reduce a participant’s taxable income in the year of the contribution. However, the distribution of the Roth contributions and, if certain requirements are met, the earnings on the Roth contributions, will be tax-free. 

SECURE 2.0 Changes

SECURE 2.0 made two changes to the catch-up contribution rules. First, catch-up-eligible participants whose wages for the prior year from the employer sponsoring the plan exceeded $145,000 (indexed) may make catch-up contributions only on a Roth basis (the Roth catch-up rule). Second, participants who would attain age 60 through 63 in a plan year may make higher catch-up contributions (the super catch-up rule). In the proposed regulations, the IRS gave some useful guidance, but additional guidance would be most helpful in some areas.

Applicability Dates: January 1, 2025 for Super Catch-Up and January 1, 2026 for Roth Catch-Up

Under SECURE 2.0, the Roth catch-up rule was effective for taxable years beginning after December 31, 2023, while the super catch-up rule was effective for taxable years beginning after December 31, 2024. However, in Notice 2023-62, the IRS provided for a two-year administrative transition period beginning after December 31, 2023, during which the Roth catch-up rule will not be enforced. Plan sponsors must start complying with the Roth catch-up rule effective January 1, 2026. The applicability date of the super catch-up rule was not changed by Notice 2023-62, and it became effective on January 1, 2025. 

The regulations are proposed to apply to contributions in years that begin more than six months after final regulations are issued, with a delayed applicability date for collectively bargained plans. If the final regulations are issued after June 30, 2025, they will not apply on January 1, 2026, even though plan sponsors will need to comply with both the Roth catch-up rule and the super catch-up rule as of that date. 

The Roth Catch-Up Rule

Under Code Section 414(v)(7), there is a special rule for a participant whose FICA wages for the preceding calendar year exceed $145,000. This advisory refers to them as older highly paid employees (OHPEs). OHPEs cannot make catch-up contributions on a pre-tax basis. OHPEs may make catch-up contributions only on a Roth basis. If any OHPE may make catch-up contributions, the plan must allow all catch-up-eligible participants to make elective deferrals on a Roth basis. The $145,000 limit is indexed for plan years beginning after December 31, 2024. 

What compensation is used for the Roth catch-up rule?

Under the proposed regulations, you must look at the FICA wages in the prior year from the employer sponsoring the plan. This differs from all the other definitions of compensation used in administering qualified plans, so now there is a new data item that needs to be tracked. 

FICA wages are determined by reference to FICA taxes imposed for Social Security purposes under Code Sections 3101(a) and 3111(a) (which are capped by the Social Security taxable wage base), rather than Medicare taxes under Code Sections 3101(b) and 3111(b). In other words, you look at Box 3 of Form W-2 for the prior year. 

There are a few other implications of this rule:

• Plan administrators and recordkeepers will need to monitor three categories of employees for tax-qualification purposes. Different compensation is used to determine whether an employee is an OHPE, a highly compensated employee (HCE), or a key employee. The determination of an employee as an HCE and key employee is relevant for other tax-qualification purposes. Given the different thresholds and sources of compensation considered in each determination, it is entirely possibly that an employee may be an HCE but not an OHPE, or vice versa.
• Venn Diagram of Categories of Highly Paid Employees
  
  
  
• No Roth catch-up rule in the first year of employment. A new employee would never be an OHPE in the first year of employment, even if the current year’s wages exceed the wage limit. This is because the new employee never had FICA wages from the employer in the prior year.
• No proration required for mid-year hiring. For the subsequent year, wages of the first year of employment would not be prorated for determining whether the wage threshold was reached.
  
  

For example, assume a catch-up-eligible employee is hired on July 1, 2025 and receives $100,000 in wages for 2025. For 2025, the employee is not an OHPE because she had no FICA wages in 2024. For 2026, the employee is not an OHPE because her FICA wages in 2025 did not exceed the requisite threshold (even though the annualized wages for 2025 exceeded the threshold).



• No Roth catch-up rule for employees exempt from FICA. If the employee did not have FICA wages from the employer, such as a partner in a firm who only had self-employment income or a government employee whose wages were exempt from FICA taxes, the employee would not be an OHPE. Similarly, a participant in a nonqualified deferred compensation plan whose benefit was subject to FICA taxes in earlier years under the special-timing rule of Code Section 3121(v)(2) would not be an OHPE unless the employee had sufficient FICA wages during the look-back year.
  
  

  Attorney A is a catch-up-eligible counsel in a law firm in 2025 and receives FICA wages for that year. Attorney A’s Form W-2 for 2025 shows FICA wages in Box 3 exceeding $145,000 (as indexed). Attorney A becomes a partner in her law firm on January 1, 2026 and receives self-employment income in 2026. Attorney A will be an OHPE in 2026 because she received the requisite FICA wages in 2025 even though she is currently not receiving FICA wages. Assume Attorney B is a catch-up-eligible partner in a law firm in 2025 and receives self-employment income for that year. He receives Form K-1 rather than Form W-2 for 2025. B becomes a senior counsel in his law firm on January 1, 2026 and receives wages that would be reported in Form W-2 for 2026. B will not be an OHPE in 2026 because he did not receive FICA wages in 2025 from his employer.

Who is the employer?

The determination whether a participant is subject to the Roth catch-up rule depends on the FICA wages ‘‘from the employer sponsoring the plan.” The preambles to the regulations say that the term “employer sponsoring the plan” refers to the common-law employer contributing to the plan. Under this definition, a plan can have multiple sponsoring employers. In other words, a participating employer is an employer sponsoring the plan, even if under the plan document or for Form 5500 purposes, the sponsor is another employer. 

If an employee moves from one controlled group member to another, the plan administrator will need to track the wages by employer. An employee may be an OHPE in one year but not in the next year simply by moving from one controlled group member to another.

This rule, if adopted, will be particularly challenging for employers who use the “common paymaster” rule. The common paymaster rule allows a related employer to be treated as a single employer for purposes of FICA wages if the common paymaster (1) employs the same employees concurrently with one or more related corporations; and (2) disburses compensation on behalf of itself and the other related corporation that concurrently employs the employees. However, for the Roth catch-up rule, only wages disbursed on behalf of the current common-law employer will be relevant for the determination even if the common paymaster paid all wages for the common-law employer and the other related employer.

Deemed Roth catch-up election

Under the proposed rule, plans may provide that a participant who is subject to the Roth catch-up rule is deemed to have elected to designate any catch-up contributions as Roth. In such plans, a participant would not need to make an affirmative election to make catch-up contributions on a Roth basis. This is true even if that plan requires a separate election for pre-tax and Roth contributions for non-catch-up contributions. However, the proposed regulations require that plans must provide an effective opportunity to elect out of the deemed election. In other words, participants must be allowed to cease making any catch-up contributions.

Although the deemed Roth catch-up election is optional, it is required if the plan sponsor wants to take advantage of the corrections methods described below.

Availability of Roth catch-up contributions

If any OHPE makes catch-up contributions, all catch-up-eligible participants must be allowed to make catch-up contributions on a Roth basis. Even non-OHPEs must be allowed to make catch-up contributions on a Roth basis.

The proposed regulations also give guidance on the application of the above rule to plans that are dual-qualified in the United States and Puerto Rico. The Puerto Rico Code does not allow Roth contributions but does allow after-tax contributions. The proposed regulations provide that a dual-qualified plan will not fail the Roth catch-up rule, if catch-up-eligible Puerto Rican participants are allowed to make catch-up contributions as after-tax contributions.

Are plans required to offer a Roth contribution program?

The IRS says no. The proposed regulations would not require a plan to allow Roth contributions. However, if a plan does not have Roth contributions, then OHPEs cannot make catch-up contributions. But non-OHPEs may still make catch-up contributions.

The IRS further stated that a plan may not require catch-up contributions for non-OHPEs to be made on a Roth basis.

Determining the Roth catch-up contributions for purposes of the rule

The proposed regulations provide that any Roth contributions made during the year, including those made before the limit under Code Section 402(g) was reached for the year will be considered for purposes of satisfying the Roth catch-up rule. Therefore, as long as the OHPE makes a Roth contribution equal to 100% of the catch-up contribution, the rule will be satisfied. Catch-up contributions do not start until the participant has reached the regular elective contribution limit for the year, regardless of how those contributions are designated in the payroll system.

Corrections for failure of the Roth catch-up rule

We can expect plans to have failures of the Roth catch-up rule, i.e., catch-up contributions were made on a pre-tax basis when they should have been made on a Roth basis. The proposed rules allow two methods of correcting such failure by transferring the catch-up contribution from pre-tax to Roth accounts. To use these two methods, a plan must have in place procedures designed to comply with the Roth catch-up rule. Specifically, the proposed rules require that a plan provide for a deemed Roth catch-up election in order to use the two correction methods below. 

• Form W-2 Correction Method. Under this method, elective deferrals from the pre-tax account are transferred to the Roth account. The amount transferred (not adjusted for any gain or loss) is reported as a Roth contribution on the Form W-2. That amount is includible in the gross income as if the contribution had been made as a Roth contribution. This method may be used only if the Form W-2 has not been issued by the time of the correction. This means plan administrators must identify and fix the error during the calendar year or shortly after the end of the year since Forms W-2 are due by January 31.
• In-Plan Roth Rollover Correction Method. Under this method, a participant’s elective deferrals (adjusted for any gain or loss) are directly rolled over from the pre-tax account to the Roth account. In other words, this is an in-plan Roth rollover in accordance with Code Section 402A(c)(4)(E). The rollover would be reported on Form 1099-R for the year of the rollover, and the amount of the rollover would be includible in the employee’s gross income. This would generally need to be done by April 15 of the year after the year of the failure. The proposed regulations don’t say whether the in-plan Roth rollover feature must be made available to all participants. 

The proposed rules do not address how to correct a failure involving a participant who terminates employment and takes a full distribution before the error is identified and corrected. Upon a full distribution, it is too late to correct under either the Form W-2 method or the in-plan Roth rollover method. 

The Super Catch-Up Rule

Starting January 1, 2025, plans may offer a higher dollar catch-up limit to employees who would attain exact ages 60, 61, 62, or 63 by the end of the year. For those participants, the limit is 150% of the regular dollar catch-up limit. For 2025, the catch-up limit for this group is $11,250 instead of $7,500. In future years, the limit will be adjusted for cost of living. If an employee is currently age 59 but will be age 60 by the end of the year, the super catch-up rule would apply to that employee. Conversely, if an employee is currently age 63 but will be age 64 by the end of the year, that employee is not eligible for the higher catch-up limit.

There is a “universal availability rule” that requires that if one participant is eligible to make catch-up contributions, then all plan participants aged 50 and over must be allowed to make catch-up contributions. This rule applies to the controlled group, so if one plan in the controlled group allows catch-up contributions, then all plans must allow catch-up contributions. Similarly, if employees aged 60–63 are allowed catch-up contributions up to $11,250, then other catch-up-eligible employees must be allowed catch-up contributions of up to $7,500. It also appears that if one plan allows super catch-up contributions, then all plans in the controlled group must offer super catch-up contributions. 

The proposed rules state that a plan is not required to offer super catch-up contributions. 

Next Steps

The Roth catch-up rule will be applicable on January 1, 2026, even if we don’t have final regulations effective as of that date. Plan sponsors and administrators may want to make sure that their systems are in place to be effective as of January 1. Below are some steps they can take now:

1. If there are multiple participating employers in a plan, confirm that the payroll providers are able to differentiate between distinct common-law employers. This is especially important if the employer uses a common payroll master that does not distinguish wages between different employers. Without clear information on FICA wages from each common-law employer, it will be hard to determine which employees are subject to the Roth catch-up rule.
2. Consider whether a deemed Roth catch-up election would make sense for the plan. This feature would help reduce errors by requiring that all catch-up contributions from eligible participants be made on a Roth basis. It is also required in order to use the proposed correction methods. However, there may be administrative reasons to not implement this feature.
3. Confirm with the payroll provider and recordkeeper that it has the capabilities to identify participants subject to the Roth catch-up rule early in the year, before any participant has contributed $23,500. Some participants may reach their 402(g) limit early in the year, and, if they are not identified early enough, may make catch-up contributions on a pre-tax basis. The problems will be compounded if such employees have already taken a distribution by the time the error is discovered.
4. Confirm with the recordkeeper that it has the capabilities to identify OHPEs and monitor their contributions throughout the year. The OHPEs must be identified by employer and their contributions monitored separately for each employer that pays the OHPE, because an employee may be an OHPE for one employer in the plan but not  for another employer in the plan. Many recordkeeping systems don’t wait for an employee to have met the 402(g) limit for the year before allowing them to make catch-up contributions. Employees can make regular and catch-up contribution elections at the beginning of the year, but there will be no catch-up contributions if the employee never reaches the 402(g) limit during the year. In those cases, the recordkeeper should be able to determine whether a participant has made sufficient Roth contributions or whether subsequent contributions will need to be on a Roth basis in order to satisfy the Roth catch-up rule. If the 401(k) recordkeeper is not able to track OHPE status and contributions by employer, that functionality will have to be built into the employer’s payroll system. Such programming can take six to nine months to accomplish, so employers are advised not to wait too long before starting the process. 

Much of the advice in this advisory assumes that the proposed regulations are valid interpretations of the statutory provisions and that the final regulations will be similar to the proposed regulations. There may be instances when an employer would like to take, or as a practical matter must take, a position different from the proposed regulations. We are available to discuss such situations with clients on a case-by-case basis. 

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