New IRS Guidance on the New Roth SEPs and SIMPLEs

Almost one year after the SECURE 2.0 Act passed into law, the IRS is issuing guidance to help employers, IRA owners, and service providers begin implementing some of the changes made by the Act. This guidance, Notice 2024-02, provides information on 12 provisions from SECURE 2.0, including the provision that allows employees to designate SEP or SIMPLE IRA plan contributions as after-tax Roth IRA contributions.

Although the option to treat SEP and SIMPLE IRA contributions as Roth was effective beginning in 2023, a lack of guidance on plan documents, tax issues, and timing has prevented IRA providers from being able to offer these enhanced features to SEP and SIMPLE IRA plans. While this notice provides insight on taxation and certain IRS reporting, much is left to the imagination as to how and when these provisions can be implemented. More detailed guidance is needed in the form of plan documents, IRA documents, model notices and timing, but here’s what we know today: 

Employers have options – Employers are not required to offer a Roth option in their SEP or SIMPLE IRA plan. If they choose to offer it, they can offer Roth treatment just for employee contributions, just for employer contributions, or for both.

Existing IRA documents can be used – The documents used to establish SEP and SIMPLE IRA plans—and the IRAs to hold plan contributions—need to be updated for several major law changes that have occurred since these documents were last published or approved by the IRS. Until the IRS issues new documents or other guidance, existing documents may be used without formal amendment. This clarifies that plan and IRA establishment documents do not need to be updated to allow the new provisions, and Roth contributions made for an employee under a SEP or SIMPLE IRA plan will be deposited into a Roth IRA.

Notice and elections are required – If an employer wants to offer a Roth option, the employer must make a written election. Employers must also give employees the same opportunity to make Roth contribution elections as is given for making pre-tax contribution elections for SIMPLE IRA plans, and SEP plans must provide an “effective opportunity.” These conditions may require additional adoption agreement-type elections for employers and additional notices for employees. Employees must elect in writing to treat contributions as Roth before the contributions are made to the plan. Employers cannot default employees into Roth contributions, such as with an automatic enrollment feature in a SIMPLE IRA plan.

Employee Roth deferrals require payroll changes – If an employee elects to treat their SIMPLE IRA salary deferral as Roth, the employer (or payroll provider) will calculate the deferral amount after calculating payroll taxes. In other words, these contributions are subject to income tax withholding, FICA, and FUTA taxes. Employees must include Roth deferrals in their taxable income for the same year in which the employee would have received the money as wages. These after-tax deferrals will be reported to the employee and the IRS by the employer on Form W-2, Wage and Tax Statement.

Employee Roth treatment of employer contributions is more complicated – If an employee elects to treat employer contributions under a SEP or SIMPLE IRA plan as Roth contributions, the employer will make and deduct the contribution in the same manner as they have historically done. However, a Form 1099-R must be generated to report the amount of employer contributions as a taxable conversion to the employee’s Roth IRA. This reporting will trigger taxation for the employee in the year the contribution is made (regardless of whether the contribution was made for the prior plan year.) Employees must be made aware of this timing distinction for tax planning purposes.

Next steps

The IRS has taken the first step in assisting employers, IRA owners, and service providers with understanding how SEP and SIMPLE Roth contributions may be made. But there are still many unanswered questions, such as whether providers will draft addendums to plan agreements to capture employer elections, the timing for notifying employees of new features and capturing their elections, when the features can be added to existing plans, and whether SIMPLE-Roth assets can be commingled with regular Roth assets.

IRALOGIX is working diligently to ensure our platform and procedures continue to assist our clients in navigating the regulatory framework and new opportunities. We will provide further updates in the months ahead.