Until recently, participants receiving matching and nonelective contributions could only have had those contributions treated as pre-tax – not subject to withholding for federal income tax, Social Security or Medicare tax.
That’s changed. Recent retirement law changes permit participants to elect to have employer matching and nonelective contributions treated as Roth contributions instead of the traditional pre-tax employer contribution. This means:
- The participant pays income tax now on the contribution.
- Future qualified distributions of that contribution and its earnings are tax-free.
- The employer still deducts the contribution as a business expense.
How Does It Work?
1. Plan Document. The Plan must specifically permit designated Roth employer contributions. Most existing documents do not unless they have been amended.
2. Participant Election. The participant must make an affirmative election. The employer cannot automatically treat employer contributions as Roth.
3. Contributions Must Be Fully Vested. Only contributions that are 100% vested when allocated may be designated as Roth employer contributions. If the contribution is subject to a vesting schedule, it cannot be treated as Roth until vested.
4. Recordkeeper Support. The recordkeeper must be able to maintain a separate Roth employer contribution source. Many systems have only recently added this capability.
5. Tax Reporting. Unlike Roth salary deferrals, these contributions are generally reported on Form 1099-R for the year they are allocated to the participant’s account, even though no cash is distributed. The amount is taxable in that year.
6. Payroll Coordination. Payroll processors need to know the taxable amount so it is reflected correctly for the participant’s tax reporting. Although the contribution is taxable income, it is generally not subject to federal income tax withholding, Social Security, or Medicare withholding merely if it is designated Roth.
What Are the Pros and Cons?
It may appeal to participants who:
- Expect to be in a higher tax bracket in retirement.
- Want to build Roth assets more quickly than salary deferral limits alone allow.
- Have cash available to pay the current tax.
But some employers may not adopt it.
- It increases administrative complexity.
- Employees need education about the tax consequences.
- Many employees prefer to defer taxes rather than pay them immediately.
Moving Forward
Retirement planning is rarely about finding one right answer. It’s about understanding the choices available and selecting the ones that are the best fit. Roth employer contributions provide a unique opportunity for employers and participants to work together to make informed retirement planning decisions.
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