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What You Need to Know

  • The legislation created an option to allow employees to treat employer-matching contributions to 401(k)s as Roth contributions.
  • The act also created a mandatory auto-enrollment rule for retirement plans with a cash or deferred arrangement.
  • The guidance addresses some provisions that are already in place and others that will become effective.

Just before the Christmas holiday, the Internal Revenue Service issued long-awaited guidance on various provisions under the Setting Every Community Up for Retirement Enhancement (Secure) 2.0 Act. The guidance, which comes in a question-and-answer format, addresses some provisions that are already effective and others that will become effective in the coming year or shortly thereafter.

Most of the guidance is applicable to any sponsor of a retirement plan and addresses issues such as employer Roth contribution requirements, mandatory auto-enrollment rules, the de minimis financial incentive provision and the new terminally ill exception to the 10% penalty for early distributions. 

Both employers and employees should pay close attention to the guidance to fully understand their rights and responsibilities.

Employer Roth Contributions

The Secure Act created an option to allow employees to elect to treat employer-matching contributions to 401(k)s as Roth contributions, which are made on an after-tax basis and are tax-free when withdrawn. 

Under the new guidance, the IRS has clarified that participants must be allowed to make a Roth election at least once per year. Presumably, that election could cover all employer-matching contributions made throughout the year. The participant must be fully vested in order to make the Roth election, and the plan is still entitled to have a vesting schedule.

Contributions are subject to income tax in the year of contribution but are not subject to employment taxes. Contributions are reported as in-plan rollovers in Form 1099-R.

A plan may also be permitted to allow only employer Roth contributions without also allowing employee Roth deferrals. 

Grandfathering Rules for Mandatory Auto-Enrollment

Secure 2.0 created a mandatory auto-enrollment rule for retirement plans with a cash or deferred arrangement. However, arrangements that were established before Dec. 29, 2022, are grandfathered and thus exempt from the new rule.

The IRS clarified that when two plans that are grandfathered merge, grandfathered status will not be lost. Further, a plan will not lose grandfathered status by merging with another plan maintained by more than one employer if that plan includes a grandfathered cash or deferred arrangement.

On the other hand, if a non-grandfathered plan merges with a grandfathered plan, the ongoing plan will not be grandfathered unless the merger occurs by the end of the IRC Section 410(b)(6)(C) transition period.

Distributions Made Due to Terminal Illness

Secure 2.0 creates an exception to the IRC Section 72(t) 10% early distribution penalty for distributions made on account of a participant’s terminal illness (the distribution is not exempt from income tax).

The IRS clarified that self-certification is not sufficient and that the employee must provide evidence and documentation as required by the employer. That evidence must include the certifying physician’s name and contact information, as well as a description of the evidence used to conclude that the individual suffers from a terminal illness.

The IRS also clarified that terminal illness means that the individual has been certified by a physician as having an illness or physical condition that can reasonably be expected to result in death in 84 months or less after the date of the certification.

While plans are not strictly required to offer the terminal illness exception, employees may elect to treat an otherwise permissible in-service distribution as a distribution based on terminal illness via Form 5329, filed with their income tax return.

De Minimis Financial Incentives

Secure 2.0 included an exception to the contingent benefit rule, which generally provides that employers cannot offer any benefit that is contingent on the employee making contributions to the retirement plan in question.

The IRS clarified that a de minimis financial incentive is one that is worth no more than $250. The financial incentive is treated as taxable income to the employee.

Further, the de minimis financial incentive can only be offered to employees who do not already have a deferral arrangement in place. Matching contributions cannot qualify as de minimis financial incentives, and the incentive is not treated as a plan contribution.

Conclusion

The IRS has extended the amendment deadline for changes related to Secure 2.0 from Dec. 31, 2025, to Dec. 31, 2026 — and employees should take note of the amendments that are adopted to understand their new rights under the plan.

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Robert Bloink

William H. Byrnes

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