Catching Up On Catch-Up Contributions, Part 2 – Rothification Strikes Back

A long time ago, in a Congress far far away, SECURE 2.0 (S2) was enacted...

This post is a sequel to a previous one (and the middle post in our trilogy) on the new regulations issued earlier this month on changes that S2 made to catch-up contributions when it was enacted back in December 2022. That previous post discusses the increased catch-up contribution limits, while this one focuses on the requirement that certain higher-paid participants must make their catch-up contributions as Roth. The third addresses how to correct mistakes in applying the new rules. As is typical of many trilogies, this middle installment is the longest.

On its face, this new rule says that any participant who was paid more than $145,000 by the plan sponsor in the immediately preceding year must make all catch-up contributions as Roth for the current year. This change was slated to take effect in 2025, but the IRS postponed it until plan years beginning in 2026.

Easy, right? Nope. Let’s take this step-by-step.

Compensation Paid

This can start to feel like being lost in a forest in a hurry, so we will try not to go too far into the trees. For starters, the $145k limit is based on what an employee is actually paid, not his or her compensation rate. Furthermore, the limit is not pro-rated for an employee who came on board mid-year. Here is a quick example.

Hoth Heating & Cooling hires Luke as its new COO on October 1, 2025, at a salary of $250,000 per year. By the end of 2025, Hoth has paid Luke $75,000. Since his actual pay for 2025 is under $145,000, Luke does not have to make his catch-up contributions as Roth in 2026. However, if he works for Hoth for all of 2026 and receives his full $250,000, his 2027 catch-up contributions must be Roth.

This is where things take a turn. This part of the law looks at FICA wages. That creates two unusual outcomes.

Self-Employment Income Doesn’t Count

Think Schedule C for a sole proprietor and K-1 for a partner in a partnership (K-1 income for an S-Corp shareholder is already disregarded for all plan purposes). A couple more examples are in order.

Rey’s business, Millennium Transportation, is a sole proprietorship. After her accountant reviews the company financials for 2025, it is determined that her 2025 earned income from Millennium is $155,000. While that amount is clearly above the threshold, it is reported on Schedule C and is not FICA wages. Since Rey did not receive any FICA wages from Millennium for 2025, she is not subject to the Roth catch-up requirement for 2026.

Solo & Associates, LLP is a law firm partnership. Cara is an associate attorney in the firm from January 1, 2025, through June 30, 2025, when she becomes a partner. Cara received W-2 pay of $125,000 for the first half of the year while an employee. After year-end, it is determined that her share of partnership profits is $200,000. That puts her total pay for the year at $325,000. Since partnership income does not count as FICA wages, we ignore it when looking at the $145,000 limit. Since Cara’s FICA wages for 2025 are only $125,000, she is not subject to the Roth requirement.

Company-by-Company Review

For almost everything concerning retirement plan compliance, we look at related companies on a combined basis. Not this time. When it comes to applying the $145,000 limit, we look at compensation paid by the participant’s “common law” employer on a stand-alone basis even if that employer is legally related to another company.

Empire Motors, Inc. and Rogue Racing, LLC are related to each other as part of the same controlled group. Both companies are adopting employers of the Rogue Empire 401(k) Plan. Galen works for both companies during 2025. Empire pays him $140,000 for the year, and Rogue pays him $135,000, bringing his total pay from both companies to $275,000. Since Galen did not receive more than $145,000 in pay from either entity, he is not subject to the Roth requirement even though his total from all related companies is well above the threshold. The result is the same if Empire and Rogue are not related and the plan is a multiple employer plan.

These two outcomes certainly seem to open the door for anyone so-inclined to monkey with their company structures and/or compensation arrangements to avoid the requirement. And “monkey with” is a technical term, so be careful how you use it.

Making a Roth Election

We should start by mentioning that even though Roth catch-ups are mandatory for those over the compensation limit, all participants (regardless of pay) must be given the option to elect Roth treatment for their catch-up contributions.

Getting back to those covered by the mandate, companies can generally approach participant elections in a couple ways.

• Deemed Election. A plan can provide that any participant subject to the Roth requirement is deemed to have elected to make catch-up contributions as Roth even if his/her “regular” deferrals are pre-tax. Of course, the participant in question must be given the ability to stop making deferrals upon reaching the regular deferral limit if s/he doesn’t want to make Roth catch-ups.
• Automatic Discontinuance. Under this option, a participant who is subject to the requirement and is making pre-tax deferrals has his/her deferrals automatically discontinued upon hitting the regular deferral limit unless/until s/he makes an affirmative election to make Roth catch-up contributions.

Either option is acceptable, but…you guessed it…whichever option a sponsor chooses must be applied consistently. Also, taking advantage of the two new methods for correcting mistakes in this area is contingent on a plan applying the deemed election option. More on that in Part 3 of this trilogy.

All of this assumes a plan otherwise allows Roth contributions, but what if that’s not the case? For most plans, the answer is pretty simple…it means those making more than $145,000 cannot make catch-up contributions at all. We say “most” because there is an exception for Puerto Rico plans. Puerto Rico has its own tax code. It does not allow for Roth contributions of any kind, but it does permit after-tax contributions. For Puerto Rico plans that offer that option, the rules work more or less the same way except that catch-up contributions are made as after-tax rather than Roth. We should also note that the limit on catch-up contributions under the Puerto Rico code is only $1,500 (for 2024, indexed for inflation).

What about timing? Must salary deferrals made later in the year be the ones designated as Roth since deferrals only become catch-up contributions after they exceed a “regular” limit? Good question. Thankfully, the answer is no. The proposed regulations make it clear that as long as a participant has Roth deferrals at least equal to the amount of his/her catch-up contributions for the year, it doesn’t matter which deferrals during the year were Roth and which were pre-tax.

Conclusion

We know there are a lot of details to keep track of with these new rules. If you have any questions about how they might apply in your particular situation, give us a call. At least there is the silver lining that none of this kicks in until 2026.

Join us for the final episode in this trilogy – Return of the Plan Correction – where we will take a look at, yup, plan correction options and cover a couple of other miscellaneous items.