After SECURE 2.0: Rethinking Roth 401(k) vs. Roth IRA

Did SECURE 2.0 change the decision-making regarding whether to contribute to a Roth 401(k) or a Roth IRA?^[i] Yes, and no. Participants should keep an eye on any actions a plan sponsor takes (or fails to take) in amending their 401(k) plan following SECURE 2.0.

But most retirement savers can achieve the best outcome by leveraging the superior features incorporated in each account—both the Roth 401(k) and the Roth IRA.

Much remains unchanged

SECURE 2.0 left unchanged many features where Roth 401(k) may be superior:

• Higher contribution limits from wages—in 2024^[ii]: 
  • Roth 401(k) – $23,000 plus $7,500 catch-up for those age 50+.
  • Roth IRA – $7,000, catch-up for those age 50+ $1,000.

However, those who want to max out contributions on a Roth basis, should use both.

• Most 401(k) plans (96%) match 401(k) contributions—whether on a pre-tax or Roth basis.^[iii]
• Roth 401(k) contributions can only be made by deferral of wages from payroll, potentially subject to automatic enrollment and escalation, facilitating retirement savings.
• Income limits do not restrict Roth 401(k) contributions.^[iv]
• In plans subject to ERISA, Roth 401(k) contributions receive ERISA’s fiduciary protections (investments, claims, appeals, etc.)
• In most employer-sponsored plans, Roth 401(k) contributions can be accessed tax-free using plan loan provisions,^[v] and where the loan principal is Roth 401(k) contributions and earnings thereon, the loan interest a participant pays to their own account, if distributed after age 59½ and 5 years of Roth participation, may be tax free.
• Often depending on the size of the 401(k) plan, the Roth 401(k) participant may have access to institutionally priced investments with lower fees, as well as investment options that may not be available in Roth IRAs.
• Because many, perhaps most participants are not investment professionals, many plans offer a Qualified Default Investment Alternative selected by the plan investment fiduciary.
• A 401(k) plan can add a Deemed Roth IRA sidecar.^[vi]
• If the 401(k) plan so provides, often with the click of a mouse, the participant has discretion to time an in-plan conversion of non-Roth assets, such as employer contributions and earnings thereon, to a Roth basis perhaps at a time when the participant has a lower federal and/or state marginal income tax rate.^[vii]

SECURE 2.0 left unchanged many features where Roth IRAs may be superior:

• Many IRA vendors now offer access to Roth IRAs with no administrative fees.^[viii]
• A few IRA vendors now offer access to index investments with low or no asset management fees – potentially of significant value for participants whose plan has higher, participant-paid administration and other costs.^[ix]
• Better access to Roth contributions:
  • While there were 641,000+ 401k plans in 2021, with 74,905,000 active participants (plus perhaps another 15+ million term vested participants), 20% of those plans do not offer access to Roth 401(k) contributions.^[x]
  • There are over 6 million organizations with employees, so, most employers do not sponsor a 401(k) plan.^[xi]
• Access to a larger choice of investments, not restricted to the 401(k) plan’s investment fiduciary’s choices.
• Contribution flexibility:
  • While qualifying wages are essential for eligibility, funds used for contributions need not come directly from wages.
  • 95+% of employers have payroll systems that use electronic banking, where almost all allow for a “split paycheck” election.
  • Roth IRA contributions can be made as late as the tax return filing deadline.
• Most 401(k) plans do not offer guaranteed income options (annuities, GMWB, GMIB, etc.) available in many Roth IRAs.^[xii]
• Roth IRA assets are generally available upon demand by the owner.
• The order of distribution from a Roth IRA is contributions first, and contributions are distributed tax free.

How SECURE 2.0 changed the Roth 401(k) vs. Roth IRA decision

• Effective for distributions from an Internal Revenue Code Section 529 (IRC §529) account after December 31, 2023, SECURE 2.0, Section 126 allows such monies to be converted to Roth IRA contributions to a Roth IRA maintained for the benefit of the IRC §529 account beneficiary if the IRC §529 account has been maintained for at least 15 years (dollar limits apply).
• For plan years beginning after December 31, 2023, a plan sponsor of a 401(k) subject to ERISA can amend their plan to add a Pension-Linked Emergency Savings Account (PLESA) as a “sidecar” (essentially another recordkeeping “source bucket”) per SECURE 2.0, Section 127. PLESA guidance^[xiii] confirms where the plan sponsor adds a PLESA account:
  • PLESAs are funded with Roth contributions per IRC §402A. 
  • Eligibility is restricted to workers otherwise eligible to contribute to the 401(k) plan (age, service, and other eligibility requirements) who are non-highly compensated employees (per IRC §414(q)^[xiv]).
  • Individuals who have established a PLESA who later become a highly compensated employee, are ineligible to make further contributions to the PLESA.
  • Participants may be automatically enrolled at a rate of up to 3% of covered compensation.
  • Contributions must be suspended once the account equals $2,500, or such lesser maximum per plan provisions.
  • Plans that include employer matching contributions must match PLESA contributions on the same basis (rate, source bucket, etc.) as any other participant contributions that qualify for a match.
  • There is no minimum contribution or balance requirement.
  • Participants must be allowed to take one withdrawal per calendar month.
  • Withdrawals are deemed to automatically satisfy in-service 401(k) restrictions.
  • In-service withdrawals or post-separation distributions (or distributions after PLESA accounts are terminated) are deemed to be “qualified distributions” – earnings are not included in gross income when withdrawn or distributed.
  • The 10-percent tax on early distributions does not apply to distributions from a PLESA:
    • Without regard to satisfying five years of participation.
    • Nor for PLESA assets rolled to Roth IRAs without regard to the five-year rule.
  • No administrative fee can be applied to the first four withdrawals per year. PLESA assets are to be invested in cash, interest bearing deposit accounts and capital preservation investments.
  • Upon separation, a participant must have the option to transfer PLESA assets to another Roth 401(k) account and must distribute any PLESA assets that are not transferred. 
  • Rollovers: 
    • In-service distributions of PLESA assets do not qualify for rollover to an IRA.
    • However, distributions after separation are eligible for rollover to a Roth IRA.
  • State anti-garnishment laws are preempted.
  • There are mandated participant notices.
  • PLESA accounts can be discontinued at any time.
• Effective for taxable years beginning after December 31, 2023, SECURE 2.0 Section 325 extended the Roth IRA pre-death Required Minimum Distribution (RMD) rules to Roth 401(k) assets. However, the plan sponsor is not required to amend the plan to permit indefinite delay in distribution of Roth 401(k) assets. So, a plan sponsor can continue to provide for a lump sum distribution that meets IRC §401(a)(14)^[xv] requirements.
• The tax qualified plan need not be amended to include the up to 10-year rule for distributions to non-spouse beneficiaries. 
• Involuntary distribution of Roth 401(k) assets can still be stranded in a Roth IRA—invested in capital preservation: unlike a direct transfer from one employer-sponsored plan to another. ^[xvi]
• Effective for taxable years beginning after December 31, 2022, SECURE 2.0 Section 601 allows for designation of SIMPLE IRAs and SEPs as Roth IRAs.
• Although delayed until taxable years after December 31, 2025,^[xvii] SECURE 2.0, Section 603 limits 401(k) catch-up contributions only as Roth 401(k) for highly compensated employees (as defined by IRC §414(q)).
• Effective upon enactment, SECURE 2.0, Section 604 provides an option for the plan sponsor to adopt provisions to permit employees to irrevocably designate 100% vested employer matching or employer non-elective contributions as Roth contributions. Such designated Roth contributions are not FICA or FUTA wages, are not included in the IRC §415 safe harbor definition of compensation and are included in the employee’s gross income in the year in which they are allocated to the account.

Keep in mind that many Roth 401(k) features may be added or excluded at the discretion of the plan sponsor. Similarly, all Roth IRAs need not incorporate all features.

SEE ALSO: 

• New Bill Seeks to Allow Roth IRA Rollovers into Roth 401(k)s

I am always interested in your comments, corrections, criticisms, and suggestions. Send them to me at jacktowarnicky@gmail.com

Disclaimer No. 1: My comments are my own based on my past experiences in plan sponsor and consulting roles and do not necessarily reflect those of any employer or association I have been employed by or affiliated with, past, present, or future.

Disclaimer No. 2: Information was provided by individuals with knowledge and experience in the industry and not as legal or tax advice. The issues presented here may have tax and legal implications, and you should discuss this matter with tax and legal counsel prior to choosing a course of action. This article is intended to be informational only. It is not and you/others should not use it as a substitute for legal, accounting, actuarial, tax or other professional advice. Any advice contained in this article was not intended or written to be used and cannot be used by anyone for the purpose of avoiding any Internal Revenue Code penalties that may be imposed on such person [or to promote, market or recommend any transaction or subject addressed herein. You (others) should seek advice based on your (their) particular circumstances from an independent tax

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^[i] C. Carosa, Why Is a Roth IRA Better Than a Roth 401(k)? Forbes, 8/25/22, Accessed 2/14/24 at: https://www.forbes.com/sites/chriscarosa/2022/08/25/why-is-a-roth-ira-better-than-a-roth-401k/  See also: C. Carosa, Why Is A Roth 401(k) Better Than A Roth IRA? Forbes, 8/25/22, Accessed 2/14/24 at:

https://www.forbes.com/sites/chriscarosa/2022/08/25/why-is-a-roth-401k-better-than-a-roth-ira/

^[ii] IRS, 401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000, Accessed 2/14/24 at: https://www.irs.gov/newsroom/401k-limit-increases-to-23000-for-2024-ira-limit-rises-to-7000

^[iii] Vanguard, How America Saves, 2023, June 2023, Accessed 2/14/24 at: https://institutional.vanguard.com/how-america-saves/overview.html

^[iv] IRS, Note ii, supra. Income phase-out range for single filers is $146,000 to $161,000, and $230,000 to $240,000 for joint filers. 

^[v] Author’s Note: While the plan sponsor may incorporate limits on plan loans, IRS regulations allow for a participant to borrow 100% of vested monies up to $10,000, or 50% of vested monies up to $50,000, whichever is greater. 

^[vi] 26 CFR § 1.408(q)-1 – Deemed IRAs in qualified employer plans.

^[vii] Author’s note: Participants need to take care to avoid triggering a 10% penalty tax following a conversion. 

^[viii] A. Benson, 16 Best IRA Accounts of January 2024: An individual retirement account, or IRA, is one of the best places to save for retirement. Here are the best IRA accounts available right now. NerdWallet, 12/1/23, Accessed 2/14/24 at: https://www.nerdwallet.com/best/investing/ira-accounts

^[ix] A. Benson, 7 Low-Cost Index Funds and 7 Low-Cost Index ETFs: Low-cost index funds make high expense ratios a thing of the past. NerdWallet, 12/1/23, Accessed 2/14/24 at: https://www.nerdwallet.com/article/investing/low-cost-index-funds

^[x] Vanguard, note iii, supra

^[xi] U.S. Census Bureau, 2021 SUSB Annual Data Tables by Establishment Industry, December 2023, Accessed 12/29/23 at: https://www.census.gov/data/tables/2021/econ/susb/2021-susb-annual.html

^[xii] Plan Sponsor Council of America, 65^th Annual Survey, 2022. 8.3% of surveyed plans offer an in-plan annuity (Lifetime Income Option)

^[xiii] IRS Notice 2024-22, Guidance on Anti-Abuse Rules Under Section 127 of the SECURE 2.0 Act of 2022 and Certain Other Issues with Respect to Pension-Linked Emergency Savings Accounts , Accessed 2/14/24 at:  https://www.irs.gov/pub/irs-drop/n-24-22.pdf See also: DOL FAQs: Pension-Linked Emergency Savings Accounts, Accessed 2/14/24 at: https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/faqs/pension-linked-emergency-savings-accounts

^[xiv] IRS, Notice 2023-75, Accessed 2/14/24 at: https://www.irs.gov/pub/irs-drop/n-23-75.pdf

^[xv] Author’s Note: IRC §401(a)(14) requires a plan to begin payment of benefits no later than the 60^th day after the close of the plan year in which the latest of the following events occurs: (1) The participant reaches the earlier of age 65 or the plan’s normal retirement age, the tenth anniversary of the employee’s participation in the plan, or the participant has a separation of service. 

^[xvi] J. Towarnicky, The 401k as an ‘Asset Magnet’: Helping to Avoid Rollover Ripoffs, 401kSpecialist.com, 7/5/22, Accessed 2/14/24 at: https://401kspecialistmag.com/how-to-make-a-401k-plan-an-asset-magnet/

^[xvii] IRS, Guidance on Section 603 of the SECURE 2.0 Act with Respect to Catch-Up Contributions, Notice 2023-62. “This notice also announces a 2-year administrative transition period with respect to the requirement under section 603 of the SECURE 2.0 Act that catch-up contributions made on behalf of certain eligible participants be designated as Roth contributions.” Accessed 2/14/24 at: https://www.irs.gov/pub/irs-drop/n-23-62.pdf