What Plan Sponsors Should Know About IRS Roth 401k Rules

As employers add Roth 401(k) options to meet growing participant demand for tax-free retirement income, plan sponsors face a complex set of IRS requirements. From plan design and amendment deadlines to precise reporting and distribution rules, each step carries compliance and fiduciary implications—and the stakes are high.

Mastering IRS Roth 401(k) rules isn’t just about avoiding penalties. It’s an opportunity to deliver a more flexible, competitive retirement benefit, streamline administration and bolster participant confidence. Whether you’re drafting plan amendments, configuring payroll systems or guiding employees through rollovers, understanding every technical detail can transform potential pitfalls into strategic advantages.

This article walks through the essentials: what defines a Roth 401(k), how to add the feature to your plan, contribution limits and eligibility, tax reporting, distribution and rollover protocols, required minimum distributions, nondiscrimination testing and real-world data on Roth adoption. Armed with clear steps and best practices, you’ll reduce sponsor risk, enhance plan value and keep your retirement offerings both compliant and compelling.

What Is a Roth 401(k) and How Does It Differ from a Traditional 401(k)?

A Roth 401(k) is an employer-sponsored retirement account that allows participants to make elective deferrals with after-tax dollars. Contributions go into a designated Roth account within the plan, grow tax-free, and—as long as certain requirements are met—qualified withdrawals of both contributions and earnings are entirely tax-free.

In contrast, a traditional 401(k) defers income tax on contributions. Employees make pre-tax deferrals, reducing their taxable income today, but pay ordinary income tax on distributions in retirement. Both vehicles invest in the same menu of funds, but the timing of the tax hit and the treatment of growth are fundamentally different.

Below is a high-level comparison:

Feature	Roth 401(k)	Traditional 401(k)
Contribution taxation	After-tax	Pre-tax
Growth taxation	Tax-free on qualified distribution	Taxable on distribution
Immediate impact on take-home pay	Higher (taxes withheld up front)	Lower (tax benefit now)
Distribution taxation	Tax-free if qualified	Fully taxable

Consider this scenario: Jane defers $10,000 in either a Roth or traditional 401(k).

In a Roth, she pays tax at her current 22% bracket (out-of-pocket tax = $2,200).
In a traditional account, her taxable income is reduced by $10,000 today (tax savings = $2,200), but in retirement she may owe a higher rate—say 25%—on both contributions and earnings.

Difference Between Roth and Traditional Contributions

Tax timing
• Roth: tax now, tax-free later
• Traditional: tax-free now, taxed at distribution
Participant cash flow
• Roth reduces current take-home pay more than traditional, but shields future withdrawals
• Traditional boosts current take-home pay, but leaves retirement withdrawals taxable
Ideal scenarios
• Roth: younger workers, rising incomes, belief in higher future rates
• Traditional: high earners seeking immediate tax relief, expecting lower retirement rates

Qualified Designated Roth Account Defined by IRS

Under IRC Section 402A, a “designated Roth account” must be separately accounted for within a 401(k), 403(b) or 457(b) plan. Employers track Roth contributions and earnings apart from pre-tax deferrals, ensuring that distributions of qualified Roth amounts remain tax-free. This separate accounting also supports proper reporting on Form 1099-R and audit trails for compliance.

Tax Advantages of Roth Contributions

Tax-free qualified withdrawals of both contributions and earnings
No income-based phase-outs for participant eligibility
Greater flexibility for estate planning and multi-generational transfers

Hypothetical growth illustrates the upside. If Jane’s $10,000 grows at 6% annually for 20 years:

Future value = 10,000 * (1 + 0.06)^20 ≈ $32,071

• In a Roth, she withdraws $32,071 tax-free.
• In a traditional account taxed at 25%, her after-tax proceeds would be:

32,071 * (1 – 0.25) = $24,053

Operational Overview for Plan Sponsors

To offer a Roth 401(k), sponsors must:

Amend the plan document and SPD to include a designated Roth feature and set effective dates
Configure payroll systems to withhold federal, state and FICA taxes on Roth deferrals and report them separately (Form W-2 Box 12, code AA)
Update recordkeeping to track Roth balances, start the 5-taxable-year clock and allocate earnings
Review distribution and rollover procedures in line with IRS Notice 2014-54, which outlines how mixed (pre-tax/Roth) distributions are processed

Partnering with your TPA or recordkeeper early in the design phase will ensure systems are tested and compliance risks are minimized.

IRS Designated Roth Account Operational Requirements

Implementing a designated Roth feature involves more than updating plan elections. Sponsors must follow the detailed operational guidance issued in IRS Notice 2014-54 to ensure distributions, rollovers and accounting processes correctly reflect the separate pre-tax and Roth components. Below are the key requirements you’ll need to address.

Allocation of Pre-Tax and After-Tax Amounts in Distributions

When a participant takes a distribution that includes both traditional (pre-tax) and designated Roth (after-tax) balances, the plan must allow them to split those amounts into separate rollovers or distributions. Notice 2014-54 clarifies that:

A single distribution event can be bifurcated: the pre-tax portion rolls over to a traditional IRA (or other eligible plan) and the Roth portion rolls over to a Roth IRA (or maintained in the plan’s Roth account).
The plan administrator must provide the participant with the amounts allocable to pre-tax and Roth on the distribution election form and on Form 1099-R.

Example scenario:
A participant with $80,000 in pre-tax contributions and $20,000 in Roth deferrals requests a rollover. The plan should permit:

A $80,000 direct rollover to a traditional IRA
A $20,000 direct rollover to a Roth IRA

This split ensures that each dollar retains its intended tax treatment and the participant avoids unintended taxable events.

Simultaneous Distribution and Rollover Procedures

Notice 2014-54 also specifies how to administer a distribution with multiple rollover destinations:

Treat the entire payment as one distribution date, even if funds are sent to different accounts.
Use distinct election codes for each portion (e.g., Code G for pre-tax, Code H for Roth) on Form 1099-R.
Issue separate checks or instructions:
- One check or ACH file to the traditional IRA or plan trustee.
- A second check or ACH file to the Roth IRA or Roth account.

From an administrative standpoint, your recordkeeper must be able to process these split elections in the same payroll run or distribution cycle. Work with them to confirm the system can handle multiple rollover designations without delaying payment or mismarking taxable amounts.

Updating Plan Documents and Procedures

To incorporate these operational rules, plan sponsors should:

Amend the plan document and summary plan description (SPD) to:
• Define the procedures for splitting mixed distributions.
• List permissible rollover destinations for each portion.
• Cite IRS Notice 2014-54 as governing authority.
Revise internal procedures and distribution forms to capture:
• The participant’s election for pre-tax vs. Roth rollover.
• Separate accounting instructions for each bucket.
Coordinate with your TPA or recordkeeper to:
• Test scenario workflows (mixed distribution, in-plan Roth rollover, etc.).
• Validate the accuracy of tax reporting fields on Form 1099-R and participant statements.

By proactively updating plan documents, distribution platforms and reporting protocols, you’ll ensure that your Roth 401(k) feature operates smoothly and remains fully compliant with IRS guidance.

Contribution Limits and Eligibility Rules for Roth 401(k)

Ensuring your Roth 401(k) feature operates within IRS limits is critical for compliance and smooth administration. From annual deferral ceilings to combined contribution caps and participant eligibility, plan sponsors must synchronize plan documents, payroll systems and recordkeeping to avoid excess contributions and testing failures.

Annual Employee Deferral and Catch-Up Contribution Limits

Participants’ Roth deferrals share the same IRC §402(g) ceiling as traditional 401(k) contributions. For 2025, the base deferral limit is $23,500. Employees age 50 or older can add a $7,500 catch-up contribution, above and beyond that limit. Since these numbers adjust for inflation each year, update your payroll and communication materials promptly when the IRS announces new figures.

Plan Year	Employee Deferral Limit	Catch-Up Contribution (50+)
2023	$22,500	$7,500
2024	$23,000	$7,500
2025	$23,500	$7,500

For a full rundown of historical and projected limits, consult the IRS Roth comparison chart.

Combined Employee and Employer Contribution Limits

Under IRC §415(c), total contributions to a participant’s account—Roth deferrals, pre-tax deferrals, employer matching or profit-sharing—cannot exceed a statutory limit. In 2025, that cap is $70,000, exclusive of any catch-up deferrals.

Plan Year	§415(c) Total Limit
2023	$66,000
2024	$69,000
2025	$70,000

Catch-up deferrals are not counted toward this combined limit. For example, a 55-year-old employee could defer $23,500 Roth, receive a $7,500 catch-up, plus up to $39,000 in employer contributions in 2025—so long as plan rules and vesting schedules allow.

Income and Eligibility Restrictions

One of the Roth 401(k)’s perks is that there’s no income phase-out for elective Roth contributions—any eligible employee, regardless of earnings, can participate. That said, the plan document may set standard entry conditions, such as:

Minimum service requirement (e.g., one year of service)
Defined enrollment windows (e.g., first of month following eligibility)

Review your plan’s eligibility provisions to confirm payroll systems only deduct Roth deferrals from participants who meet those criteria. Accurate enrollment tracking and clear participant communications help ensure everyone who can contribute knows how and when to elect the Roth option.

Plan Adoption and Document Amendments to Offer a Roth Feature

Adding a Roth option requires more than flipping a switch. Plan sponsors must take deliberate steps to amend governing documents, comply with IRS deadlines and update participant materials. A clear roadmap ensures your plan is legally sound and participants understand their new after-tax deferral opportunity.

Amending Plan Documents and Summary Plan Descriptions

To introduce a designated Roth feature, the plan document and summary plan description (SPD) must be formally updated:

Amendment Deadline
• Adopt the amendment by the last day of the plan year in which you want the feature to become effective (e.g., December 31, 2025 for a January 1, 2025 start).
• If your plan operates on a non-calendar year, use that plan year’s final day.
Effective Date
• Specify the date from which Roth deferrals and catch-up contributions may be made.
• Coordinate with payroll to ensure systems are ready to withhold taxes on after-tax deferrals as of that date.
IRS Filing Considerations
• Unless your plan has a recent favorable determination letter, this amendment generally does not require an immediate IRS submission.
• Track the amendment in your plan’s restatement cycle to maintain an up-to-date document.

Sample SPD language to notify participants:

“Effective January 1, 2025, the Plan is amended to permit participants to make designated Roth elective deferrals under IRC §402A. Roth deferrals are after-tax contributions that grow tax-free in a separate account. You will receive a revised SPD by March 31, 2025.”

Remember to distribute the updated SPD within 210 days after the amendment is adopted. This keeps you compliant with ERISA’s disclosure rules and prevents participant confusion.

Universal Availability and Nondiscrimination Testing

Under IRC §401(a)(4), Roth deferrals must be offered on the same terms as traditional elective deferrals:

Universal Availability
• All employees eligible to make elective deferrals must have the option to designate those deferrals as Roth contributions.
• You cannot carve out highly compensated or non-highly compensated employees from the Roth feature.
ADP/ACP Testing
• Aggregate Roth and traditional deferrals for actual deferral percentage (ADP) and actual contribution percentage (ACP) testing.
• If high deferral rates by key employees push ADP or ACP above IRS limits, corrective distributions or employer-made qualified nonelective contributions may be required.

Maintaining a clear record of Roth elections alongside traditional elections helps you monitor testing results in real time and avoid year-end surprises.

Participant Communication and Election Procedures

A smooth rollout depends on timely, concise communication and robust election processes:

Communication Timeline
• Initial Announcement: At least 60 days before the effective date, send an overview of the Roth feature, key dates and tax implications.
• Enrollment and Election Window: Offer a minimum 30-day period for participants to elect or change Roth deferrals.
• Ongoing Change Opportunities: Allow Roth/pre-tax election changes at least once per plan year, as specified in the SPD.
Election Form Checklist
• Participant name and identification number
• Effective date of the Roth election
• Deferral type: percentage of pay or flat dollar amount
• Allocation: Roth vs. traditional deferral split
• Participant signature and date

Sample notice copy:

“Starting January 1, 2025, you may split your 401(k) deferrals between traditional (pre-tax) and Roth (after-tax) accounts. The total annual limit remains $23,500 ($7,500 additional if you’re age 50 or older). To elect Roth deferrals, complete the attached form by December 15, 2024.”

By following these steps—amending documents on time, observing universal availability rules and equipping participants with clear election tools—you’ll lay the foundation for a compliant, well-adopted Roth 401(k) feature without administrative headaches.

Employee Deferral Elections and Administrative Procedures

Once the Roth feature is in place, participants need clear pathways to elect— and, if desired, change— their after-tax deferrals. Plan sponsors must coordinate election windows, payroll setups and system controls to ensure that Roth contributions flow correctly and comply with plan and IRS rules.

Election Timing and Frequency Requirements

Participants must have an opportunity to make or modify Roth versus traditional deferral elections at least once every plan year. While the plan document defines the precise election window, best practices include:

Opening an annual election period of at least 30 days.
Aligning the effective date of any new or changed election with a regular payroll cycle (often the first payroll of the plan year).
Allowing for off-cycle changes in special circumstances (e.g., mid-year marriage or birth), provided these windows apply equally to Roth and traditional elections.
Specifying blackout periods—dates when elections can’t change— if your recordkeeper needs time to test year-end processes. Communicate those blackout dates in advance to avoid participant confusion.

By embedding election timelines in your SPD and participant notices, you create clear expectations and reduce the risk of missed or mis-processed elections.

Automatic Enrollment and Default Roth Features

Some sponsors choose to auto-enroll new hires or re-enrollees directly into the Roth option by default. This approach can drive adoption but requires a formal opt-out mechanism:

Default deferral rate: “Unless you elect otherwise, 3% of your eligible pay will be deferred to the Plan.”
Default deferral type: “These contributions will be treated as Roth deferrals, subject to applicable deferral limits and payroll tax withholding.”
Opt-out procedure: Provide a detachable form or online portal where participants can:
- Decline participation entirely
- Change the deferral percentage
- Switch their default to pre-tax deferrals

Sample opt-out language:

“I decline automatic Roth deferrals of 3% of my pay. I understand I can re-elect at any time during the plan year.”
— Participant Signature / Date

Ensure that opt-out forms and digital platforms track these elections and feed directly into payroll to prevent unwanted Roth withholding.

Impact on Nondiscrimination Testing

Roth deferrals are subject to the same Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests as traditional deferrals. Key considerations:

Aggregation: Combine Roth and pre-tax deferrals when calculating each group’s average deferral rate.
Monitoring: Run quarterly ADP/ACP projections. Early visibility allows corrective actions— such as corrective distributions or qualified nonelective contributions—well before year-end deadlines.
Recharacterization: If testing shows high-paid employee deferrals exceed permissible thresholds, you may need to refund excess Roth deferrals to restore compliance.

By integrating Roth election data into your nondiscrimination testing cadence, you’ll avoid last-minute surprises and ensure that all participants retain their full deferral benefits without triggering prohibited allocations.

Tax Treatment and Reporting Requirements for Roth Contributions

Designated Roth contributions have unique tax and reporting rules compared with traditional 401(k) deferrals. Plan sponsors must ensure timely withholding of federal, state and payroll taxes, and accurate reporting on Forms W-2 and 1099-R. Missteps can lead to participant confusion—or IRS notices—so proactive coordination with payroll and recordkeeping is essential.

Federal Income and Payroll Tax Withholding

Because Roth 401(k) deferrals are made with after-tax dollars, employers must treat them as fully taxable wages in the pay period in which they are deferred. That means:

Federal income tax, state income tax (where applicable), Social Security and Medicare taxes apply at the usual withholding rates.
Unlike traditional deferrals—which exclude that deferral amount from federal income tax withholding—Roth deferrals increase the participant’s taxable wages in Box 1 of Form W-2.
Payroll systems must be configured to route Roth deferrals to the designated Roth account while still capturing them as taxable wages for each withholding category.

Failing to withhold correctly can trigger participant under-withholding and employer liability for unpaid payroll taxes. Perform a system test in the first payroll cycle after adding Roth deferrals to confirm proper tax calculation.

Form W-2 Reporting for Designated Roth Contributions

At year-end, sponsors report each participant’s Roth deferrals on Form W-2:

Box 1 (Wages, tips, other compensation): includes gross wages plus Roth deferrals.
Box 12: enter total designated Roth contributions using Code AA.
Box 3 and Box 5 (Social Security and Medicare wages): include Roth deferrals, since they’re subject to FICA.
Box 2 and Box 4 (Federal and Social Security withheld): reflect the additional withholding generated by the Roth deferrals.

Checklist for W-2 setup:

Confirm payroll feeds Roth amounts into Box 12 with Code AA
Verify that Roth deferrals are added back into federal, state, and FICA wage bases
Review sample W-2s early in January to catch any misclassification

Form 1099-R Reporting for Distributions

Any distribution from a designated Roth account—whether qualified, nonqualified or a direct rollover—requires issuance of Form 1099-R. Sponsors and recordkeepers should observe these key points:

Box 1 (Gross distribution): total amount distributed, including contributions and earnings.
Box 2a (Taxable amount): for nonqualified distributions, report the earnings portion here; for qualified distributions, enter “0.”
Box 5 (Employee contributions/excess deferrals): the total basis (Roth contributions) in the account at distribution.
Box 7 (Distribution code): use the appropriate code to identify the type of distribution:
- Code H: direct rollover of a designated Roth distribution to a Roth IRA.
- Code J: early distribution from a designated Roth account (nonqualified).
- Code T: Roth IRA distributions (if the rollover moved funds into an IRA).
State boxes: mirror federal information if your state requires 1099-R reporting.

Participants also rely on supplemental statements breaking out basis versus earnings—essential for accurate income tax filings. Plan administrators must furnish that breakdown within 30 days of request, or automatically when issuing the 1099-R for a nonqualified distribution.

By aligning payroll withholding, W-2 coding and 1099-R reporting with IRS rules, sponsors will keep their designated Roth feature running smoothly—and avoid surprises for both participants and the plan’s fiduciaries.

Distribution and Withdrawal Rules for Designated Roth Accounts

Participants often assume that because Roth contributions are made with after-tax dollars they can withdraw funds at will. In reality, federal rules attach specific criteria to Roth distributions. Sponsors must ensure plan documents clearly distinguish between qualified and nonqualified distributions—and outline any plan-permitted hardship and loan options—to protect both participants and fiduciaries from unintended tax liabilities.

Whether an employee’s Roth withdrawal is tax-free hinges on meeting the so-called “qualified distribution” requirements. If a participant falls short, only the portion attributable to Roth contributions (basis) is returned tax-free, while earnings may incur income tax—and potentially penalties. Below, we break down the rules every plan sponsor needs to know.

Qualified Distribution Criteria and the 5-Year Rule

A distribution from a designated Roth account is considered qualified—and therefore entirely tax-free—if it meets two conditions:

The participant has satisfied a five-taxable-year period beginning with the first January 1 of the year in which a Roth contribution was made.
The distribution occurs on or after the date the participant reaches age 59½, or is made on account of the participant’s death or disability.

For example, if Jane’s first Roth deferral is made on March 15, 2025, her five-taxable-year clock starts January 1, 2025 and runs through December 31, 2029. Any qualifying distribution—say, one taken on April 2, 2030, after her 60th birthday—would be entirely tax-free.

Nonqualified Distributions and Taxable Earnings

When a withdrawal occurs before satisfying the five-year rule or age 59½ requirement, it is nonqualified. In that case, the participant’s Roth contributions (the basis) remain tax-free, but any earnings portion is included in taxable income. Plans typically allocate distributions on a pro-rata basis:

Taxable earnings = Distribution amount × (Earnings balance ÷ Total Roth account balance)

For instance, if a participant takes a $5,000 nonqualified distribution from an account holding $9,400 of contributions and $600 of earnings, the calculation is:

Taxable earnings = 5,000 × (600 ÷ (9,400 + 600)) ≈ $300

The remaining $4,700 of the distribution represents basis and is not subject to income tax.

Hardship Distributions from Roth Accounts

If the plan document permits hardship distributions, participants may access their Roth balance under the same conditions that apply to pre-tax accounts. Employers must:

Confirm the distribution satisfies one of the IRS hardship criteria (e.g., medical expenses, casualty losses).
Document the event and the amount needed.
Apply the distribution pro-rata across basis and earnings, taxing only the earnings portion unless the five-year and age criteria are met.

Hardship withdrawals should be processed in line with the plan’s hardship policy and reported on Form 1099-R. Clear participant communications and proper documentation help ensure consistency and compliance.

Loan Provisions for Roth 401(k) Accounts

Under IRC §72(p), participants may borrow from their Roth 401(k) balance if the plan permits loans. Key sponsor considerations include:

Loans draw from the combined balance of pre-tax and Roth accounts; repayments must be tracked separately against each bucket.
The plan’s loan policy (e.g., maximum loan amount, repayment term) applies uniformly to both pre-tax and Roth loans.
Default on a Roth loan triggers the same “deemed distribution” rules and potential taxation on any earnings portion as with traditional loans.

Sponsors should work with their recordkeeper to ensure loan origination screens and participant statements clearly identify how payments reduce pre-tax and Roth balances, and to confirm that any default is reported appropriately on Form 1099-R.

Rollover and Conversion Options Involving Roth 401(k) Accounts

Participants often change jobs or seek to consolidate retirement savings, so it’s crucial for plan sponsors to understand how Roth balances can move in and out of the plan. Whether funds go to an IRA or stay in the plan via an in-plan conversion, precise procedures and reporting rules apply. Below, we outline the key pathways and IRS guidance that govern Roth 401(k) rollovers and conversions.

Rollover transactions must preserve each dollar’s tax character—Roth contributions remain after-tax, and any earnings or pre-tax dollars receive their own treatment. Sponsors should make sure distribution forms capture separate elections, systems handle multiple destinations seamlessly, and 1099-R reporting reflects each portion’s status. Clear participant communications and tested administrative workflows will minimize errors and protect both sponsors and employees.

Rollovers to Roth IRA vs Traditional IRA

When a participant leaves the plan, they may choose to roll over part or all of their account:

• Direct rollover
– Roth portion → Roth IRA (tax-free continuation)
– Pre-tax portion → Traditional IRA (tax-deferred)
• 60-day indirect rollover
– Plan issues a single check; participant deposits the Roth basis into a Roth IRA and any pre-tax funds into a traditional IRA within 60 days.
– Withholding applies only if the distribution is paid to the participant (20% mandatory withholding on the taxable portion).

Sponsors must provide a distribution statement showing the split between employee contributions (basis) and earnings. On Form 1099-R, use Code H for direct Roth IRA rollovers, and Code G for direct pre-tax rollovers. If a participant misses the 60-day window, the unrolled amounts may become taxable distributions.

In-Plan Roth Rollovers (Conversions)

An in-plan Roth rollover (sometimes called a Roth conversion) lets participants convert pre-tax balances to the plan’s designated Roth account without leaving the plan. Key points:

Eligibility: All vested balances—deferrals, matching, profit-sharing and rollover contributions—may be converted if the plan document permits.
Mechanics: The plan administrator treats the conversion as a direct rollover within the plan; no spouse consent is required.
Taxation: The converted amount (pre-tax balance plus earnings) becomes taxable income in the year of conversion. There’s no 20% withholding requirement on a direct in-plan rollover, but participants should consider estimated tax payments to cover the liability.
Recapture rule: If any portion of the converted amount is distributed from the Roth account within a five-taxable-year period, that distribution may be subject to a 10% early withdrawal penalty unless an exception applies.

Sponsors should update plan communications and participant notices to explain conversion eligibility, tax consequences and the special five-year recapture rule.

IRS Notice 2014-54 Guidance on Rollover Allocations

IRS Notice 2014-54 provides the official roadmap for handling distributions that contain both pre-tax and Roth components. Highlights include:

Single distribution date: Even if funds go to multiple destinations, treat the payment as one distribution event.
Election codes: Use distinct codes on Form 1099-R—Code G for traditional rollovers, Code H for Roth rollovers—to clearly mark each portion’s destination.
Administrative flow: Sponsors may issue separate checks or electronic instructions for each portion, but must coordinate processing so the distribution date and participant election are consistent.
Participant statements: The plan must furnish a breakdown of basis versus earnings to assist participants in tracking five-year requirements and future tax treatment.

For complete technical details, refer to the IRS’s PDF of Notice 2014-54: https://www.irs.gov/pub/irs-drop/n-14-54.pdf. Embedding this guidance into your distribution platform and training materials will keep your plan’s Roth feature audit-ready and participant-friendly.

Required Minimum Distributions and Roth 401(k) Plans

Required Minimum Distributions (RMDs) are annual, mandatory withdrawals that most retirement-plan participants must begin taking once they hit a certain age. Even though Roth 401(k) contributions grow tax-free, until recently RMD rules still applied. Understanding how and when RMDs affect designated Roth accounts is critical for both sponsors and participants.

RMD Requirements Before and After SECURE Act 2.0

Prior to SECURE Act 2.0, all 401(k) balances—including designated Roth accounts—were subject to RMDs. Participants had to start taking their first RMD by April 1 of the year following the year they turned 72 (or 70½ for those who reached that age before January 1, 2020). Failure to withdraw the correct amount could trigger a 50% excise tax on the shortfall.

SECURE Act 2.0 changed the landscape:

For the 2023 distribution year, RMDs still applied to designated Roth 401(k) accounts. Participants whose Required Beginning Date (RBD) was April 1, 2024 (i.e., they turned 72 in 2023) needed to take two RMDs in 2024: one for 2023 and one for 2024.
Beginning January 1, 2024, RMDs are eliminated for designated Roth accounts in workplace plans. Participants no longer need to take annual distributions from their Roth 401(k) balances, though RMDs continue to apply to any pre-tax balances in the same plan.

Plan Sponsor Procedures for RMD Compliance

Even though Roth RMDs vanish after 2023, sponsors must maintain RMD processes for pre-tax balances and handle any 2023 Roth RMDs correctly. Key steps include:

Segregate Account Balances
Maintain separate year-end balance reports for Roth and non-Roth components. Systems should flag Roth RMDs only for the 2023 calendar year.
Calculate RMD Amounts
Use the standard formula and IRS life expectancy tables:
```
RMD = Prior‐year December 31 Account Balance ÷ Life Expectancy Factor
```
Apply this separately to each balance bucket through 2023.
System Updates and Flags
- For 2024 and later, disable Roth RMD calculations in your recordkeeping software.
- Continue annual RMD runs for pre-tax balances, with automated notices and disbursements.
Annual Participant Notices
Issue RMD notices at least 90 days before the deadline. Clearly distinguish whether the RMD applies to Roth, pre-tax, or both, and provide exact withdrawal amounts and deadlines.
Monitoring and Audit Trail
Keep documentation of RMD calculations, participant elections and proof of distribution. This record-keeping supports ERISA compliance and defends against potential IRS inquiries.

Participant Notifications Regarding RMDs

Clear communication helps participants avoid missed-distribution penalties and plan for required withdrawals. A sample notice might read:

“Dear [Participant],
Our records show you turned age 72 in 2023. You are required to take a minimum distribution of your 2023 Roth 401(k) balance by April 1, 2024, and your 2024 RMD by December 31, 2024. Your total Roth RMD for 2023 is $X,XXX.00.
Starting in 2024, designated Roth accounts in this plan are no longer subject to RMDs. If you prefer to avoid any 2023 Roth withdrawal, consider rolling your Roth 401(k) into a Roth IRA by [insert date], since Roth IRAs are never subject to RMDs.”

Encourage eligible participants to:

Roll over Roth balances into a Roth IRA before their first RMD becomes due, eliminating future RMD obligations.
Coordinate distributions with their broader retirement strategy to manage tax impacts on Social Security and other income.

By updating procedures, educating participants and leveraging system controls, sponsors can navigate the transitional RMD rules seamlessly and help participants maximize the tax advantages of their Roth savings.

Compliance Testing and Corrective Actions for Operational Failures

Even a minor operational slip—late Roth deposits, misrouted payroll codes or missed election windows—can trigger nondiscrimination testing failures and costly IRS notices. By integrating regular monitoring, error-correction procedures and clear fiduciary protocols, sponsors safeguard plan integrity and reduce the risk of disqualification or excise taxes.

ADP/ACP Testing for Roth Deferrals

Roth deferrals count alongside traditional elective deferrals in both the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests. When highly compensated employees (HCEs) defer at disproportionately higher rates, corrective action must follow:

• Monitor quarterly ADP/ACP snapshots. Early detection of an HCE average deferral rate exceeding non-HCEs by more than the allowable percentage (typically 2%) gives you time to adjust before year-end.
• If the ADP test fails, issue corrective distributions of excess Roth deferrals (plus earnings) to HCEs by March 15 of the following plan year. These distributions restore test compliance and prevent penalties.
• Alternatively, you may make qualified nonelective contributions (QNECs) to non-HCE accounts to rebalance deferral ratios—especially useful when widespread corrective distributions would be disruptive.

Document each step—testing results, participant notices and distribution confirmations—to demonstrate due diligence in the event of an IRS audit.

Correcting Distribution and Contribution Errors

Under the IRS’s Employee Plans Compliance Resolution System (EPCRS), many operational missteps can be self-corrected or remedied through a voluntary submission:

• Common operational errors
– Late deposit of Roth or traditional deferrals (missed deposit deadlines)
– Failure to bifurcate Roth versus pre-tax contributions in distributions
– Incorrect tax withholding on Roth deferrals
– Misallocated catch-up contributions or employer matches
– Inaccurate loan origination or default reporting

• Self-Correction Program (SCP)
Eligible errors—like late remittances—can often be fixed without IRS involvement if corrected within a specified timeframe. For example, a late deposit may be cured by forwarding the deferral plus lost earnings and reporting the correction on Form 5330 (Return of Excise Taxes Related to Employee Plans).

• Voluntary Correction Program (VCP)
For more complex errors (e.g., plan document deviations or missed Roth accounting), sponsors submit a VCP application to the IRS, outline the error and propose a correction—typically restoring participant accounts, making QNECs, and paying a modest compliance fee.

By embedding an EPCRS-aware workflow—error detection, impact analysis, correction and documentation—you keep your plan in good standing and limit sponsor liability.

Penalties and Fiduciary Risk Management

Unchecked operational failures can lead to significant sponsor liability:

• Excise Taxes
– Late deposits of elective deferrals can incur a 10% excise tax under IRC §4950, increasing to 15% for repeated failures.
– Failure to correct ADP/ACP test failures by the deadline can trigger a 5% excise tax on the aggregate failed contributions.

• Plan Disqualification
Severe or uncorrected errors risk disqualification of the entire plan under IRC §401(a), stripping all participants of tax-advantaged status.

To manage these risks:

Document written policies for Roth operations—amendment procedures, deposit deadlines, distribution workflows and testing schedules.
Schedule periodic audits (internal or via your TPA) to validate that payroll, recordkeeping and communication processes align with your plan document and IRS rules.
Carry fiduciary liability insurance that explicitly covers operational errors and EPCRS-related exposures.

By pairing proactive monitoring with swift, IRS-sanctioned corrections, plan sponsors can demonstrate the prudence and diligence required under ERISA—turning compliance testing from a reactive headache into a competitive advantage.

Data Insights on Roth 401(k) Adoption and Savings Outcomes

Hard data shows how Roth 401(k) features have moved from niche to mainstream—and how participants who use them often see stronger balance growth over time. Here’s what plan sponsors need to know.

Trends in Roth 401(k) Adoption Rates

77% of plan sponsors surveyed at the end of 2022 offer a Roth 401(k) option (Transamerica Institute).
Across plans, Roth deferrals have steadily climbed, accounting for approximately 18% of total elective contributions in 2023.
The ICI/EBRI 2023 report finds that younger workers (under age 35) are adopting Roth contributions at more than double the rate of older cohorts, underscoring a generational shift toward tax-free growth strategies.

Impact on Long-Term Participant Balances

Between 2016 and 2020, average 401(k) balances almost doubled—and Roth participants often outpace that growth:

Overall average balances rose from $78,008 in 2016 to $158,361 in 2020, a compound annual growth rate (CAGR) of 19.4%.
Participants in their 20s saw a 57.4% CAGR over the same period, reflecting both aggressive savings rates and early Roth adoption.
Mid-career groups (ages 40–49) also benefited, with balance growth rates above 15% annually—demonstrating that tax diversification via Roth contributions can enhance outcomes at any career stage.

Strategic Implications for Plan Sponsors

These insights translate into actionable steps:

Prioritize Roth education for younger employees, who show the highest adoption and long-term balance growth potential.
Track Roth-versus-traditional election trends by age cohort to tailor communication and auto-enrollment defaults.
Highlight plan-level Roth participation metrics in benchmarking reports to differentiate your retirement offering and attract talent.
Combine Roth and traditional options in your fiduciary communications, helping participants optimize take-home pay today while managing future tax liabilities.

By leveraging adoption and balance-growth data, sponsors can position their Roth 401(k) feature as both a compliance win and a competitive benefit—delivering measurable value to participants and the organization alike.

Next Steps for Plan Sponsors

Adding a Roth 401(k) feature can feel like tackling a puzzle, but breaking it into clear steps will keep the process on track—and your fiduciary liability in check. Here’s how to turn the insights in this guide into action:

Amend plan documents and SPDs
• Adopt the Roth amendment by the plan year deadline
• Update participant communications and summary plan descriptions
Configure payroll and recordkeeping systems
• Enable after-tax withholding and separate Roth accounting
• Test year-end reporting for Form W-2 (code AA) and Form 1099-R
Roll out participant education and enrollment
• Announce key dates, election windows and tax implications
• Provide clear opt-out and change-election materials
Monitor ongoing compliance
• Integrate Roth deferral data into ADP/ACP testing
• Track 5-taxable-year start dates, RMD flags and rollover elections
Establish an error-correction workflow
• Define deadlines for depositing deferrals and processing distributions
• Document self-corrections under EPCRS and VCP when needed

With these steps in your playbook, you’ll move confidently from plan design to seamless administration—minimizing risk and maximizing the value of your retirement offering.

Looking for hands-on support? Visit Summit Consulting Group, LLC to see how our expert plan administration and fiduciary services can simplify your Roth 401(k) implementation and keep your plan running smoothly.