Four important new rules for Roth in SECURE 2.0
[Original published on March 7, 2023] SECURE 2.0 uses multiple levers to effect change in retirement plans and savings. Four of the act’s provisions focus on Roth—some remedy issues for participants, others either dictate or enable new uses of Roth. We’ve compiled our key takeaways from SECURE 2.0 for Roth IRAs and workplace plans.
Although Roth is the subject of four provisions in SECURE 2.0, only one covers Roth IRAs and the remaining are aimed at Roth in employer-sponsored plans.
SECURE 2.0 brings good news to 529 plans and Roth IRAs
Section 126—rollovers from 529 plans to Roth IRAs
Section 126—rollovers from 529 plans to Roth IRAs
For distributions after December 31, 2023
Summary
The designated beneficiary of a 529 account that’s been maintained for at least 15 years may request a tax-free direct rollover of the account’s assets to such designated beneficiary’s Roth IRA. The rollover may not exceed the aggregate amount contributed to the 529 account (and earnings attributable thereto) before the five-year period ending on the date of the distribution, subject to a lifetime rollover maximum of $35,000. In addition, the rollover is subject to Roth IRA contribution limits and the requirement that a Roth IRA owner have includable compensation at least equal to the amount of the rollover.
John Hancock viewpoint
This provision is welcome news for 529 account beneficiaries who have assets in their 529 account that they’re unable to use for education expenses. Currently, in order to use excess assets in a 529 account, the account owner can designate certain other family members as a new beneficiary of the account who could then use the account assets for education expenses. This provision creates a new way for a 529 account beneficiary to retain and use excess 529 account assets by rolling them over to a Roth IRA.
Aligning RMD rules for Roth IRA and workplace accounts
SECURE 2.0 simplifies required minimum distribution (RMD) decisions for some Roth account holders.
Section 325—exemption of pre-death RMDs from Roth accounts
Section 325—exemption of pre-death RMDs from Roth accounts
For taxable years beginning after December 31, 2023 (doesn’t apply to distributions that are required with respect to years beginning before January 1, 2024, but are permitted to be paid on or after such date)
Summary
This provision provides an exemption of Roth amounts in employer retirement plans from pre-death RMDs. This change aligns the RMD rules for Roth amounts under employer retirement plans with the Roth IRA RMD rules.
John Hancock viewpoint
Now that the rules will be the same for employer retirement plans and Roth IRAs, participants will be able to evaluate whether it makes financial sense to roll over their retirement plan account to their IRA or Roth IRA without having to consider inequitable RMD rules.
The administrative impact of SECURE 2.0 on Roth in employer-sponsored plans
The Roth news for employer-sponsored plans comes with both mandatory and optional new administrative requirements that sponsors should be aware of.
Section 603—catch-up contributions must be made on a Roth basis
Section 603—catch-up contributions must be made on a Roth basis
[Update] On August 25, 2023, the IRS released guidance on the effective date for Section 603. This new guidance delays until December 31, 2025, the mandate for catch-up contributions to be made on a Roth basis for participants earning more than $145,000.
[Original provision] For taxable years beginning after December 31, 2023
Summary
This provision requires that catch-up contributions under an employer retirement plan (other than a SIMPLE IRA or simplified employee pension (SEP) plan) be made on a Roth basis for participants who had compensation that exceeded $145,000 in the prior calendar year (indexed for inflation). Any other participant must be permitted—but not required—to elect to have catch-up contributions made on a Roth basis. This means that plans that don’t permit designated Roth contributions can’t permit catch-up contributions.
John Hancock viewpoint
We believe this provision will need to be monitored by payroll providers to track whether a participant’s prior year compensation exceeded the threshold. Recordkeepers may not have compensation records to administer this provision in a timely manner, especially for plans with off-calendar plan years.
Section 604—optional treatment of employer matching or nonelective contributions as Roth contributions
Section 604—optional treatment of employer matching or nonelective contributions as Roth contributions
For contributions made after December 29, 2022
Summary
With this provision, plan sponsors of 401(k), 403(b), and governmental 457(b) plans may offer participants the ability to designate employer matching or nonelective contributions as Roth contributions. Student loan matching contributions can also be designated as Roth contributions. Matching and nonelective contributions designated as Roth contributions may not be excluded from the employee’s income, but future earnings on the designated Roth contributions won’t be taxed if distributed as a qualified Roth distribution. These optional Roth employer contributions are available for fully vested employer matching and nonelective contributions. Currently, some plans offer an in-plan Roth conversion feature, whereby participants may convert previously contributed employer contributions to Roth contributions through separate employee-initiated elections. This provision extends this ability to employer contributions by allowing the acceleration of the Roth election to take effect at the time the employer contributions are contributed to the plan rather than effectuating a separate in-plan Roth conversion election later.
John Hancock viewpoint
From a practical standpoint, it may take time for plan sponsors and service providers to offer this feature. Plans that have a vesting schedule (especially a graded schedule) will need to consider how and when to offer their participants the ability to make this election and whether to make changes to the plan’s vesting schedule to facilitate these elections. Additionally, employer payroll and service providers will need to establish administrative processes for soliciting and processing employees’ elections and withholding requirements of any employee-elected matching or nonelective contributions as taxable income.
Another consideration is how sponsors will likely want to communicate the availability of this election to their employees and provide employees with resources that explain the tax implications.
The Roth provisions provide plenty to ponder
While the rollovers from 529 and alignment of RMD rules are good news for participants, the remaining Roth provisions—Sections 603 and 604—have administrative repercussions likely to have an impact on retirement plans. As always, consult with a trusted financial professional or plan consultant to determine what’s best for your plan. And if you’d like to learn more about what else the legislation covers beyond Roth, please visit our Getting to know SECURE 2.0 Act resource page.
Important disclosures
In this article, all tax disclosures regarding Roth 401(k) contributions are limited to the federal income-tax code and, in particular, all references to tax-free treatment of qualified distributions are intended to refer to the treatment of such distributions at the federal level only.
This content is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made.
John Hancock Retirement Plan Services LLC offers administrative and/or recordkeeping services to sponsors and administrators of retirement plans. John Hancock Trust Company LLC provides trust and custodial services to such plans. Group annuity contracts and recordkeeping agreements are issued by John Hancock Life Insurance Company (U.S.A.), Boston, MA (not licensed in NY), and John Hancock Life Insurance Company of New York, Valhalla, NY. Product features and availability may differ by state. Securities are offered through John Hancock Distributors LLC, member FINRA, SIPC.
John Hancock Investment Management Distributors LLC is the principal underwriter and wholesale distribution broker-dealer for the John Hancock mutual funds, member FINRA, SIPC.
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