The SECURE 2.0 Act of 2022 includes a provision that would limit employees with prior year FICA wages above an IRS dollar threshold to making only Roth contributions under the Age 50+ catch-up to 403(b) and governmental 457(b) plans.
But wages paid to educators in Ohio K-12 public school districts generally are not subject to FICA. That means that Ohio K-12 school district employees have the choice of contributing to their school district’s 403(b) and 457(b) plans on a pre-tax and/or Roth basis or a combination of the two.
Why would an educator consider making Roth contributions to these plans?
Earnings on Roth contributions may not be subject to federal income tax when distributed.
Roth contributions to a 403(b) or governmental 457(b) plan are subject to federal income tax when contributed rather than when distributed. Earnings on Roth contributions grow tax-deferred, just like earnings on pre-tax deferrals.
However, earnings on Roth contributions will not be subject to federal income tax when a participant takes a distribution under the school district’s 403(b) or 457(b) plan if both of the following conditions are met:
- Completion of the 5-year holding period. This 5-year holding period generally is measured beginning with January 1 of the first calendar year that the participant made a Roth contribution to the plan.
- Example: a participant makes a Roth contribution to their school district’s 457(b) plan in June 2022; the participant has not rolled over any Roth contributions into the 457(b) plan. The 5-year holding period begins on January 1, 2022 (the first day of the calendar year that the first Roth contribution was made) and is completed on December 31, 2026.
- Special rule for rollovers into the plan: If the first Roth contribution to the plan is a direct rollover of Roth contributions from a 401(k), 403(b), or governmental 457(b) plan, the 5-year holding period begins on January 1 of the calendar year that the first Roth contribution was made to that prior plan.
- Distribution after the participant attains age 59½, disability, or death.
What happens if a participant takes a distribution from the plan, but has not met both of these conditions?
- Earnings on Roth contributions distributed to a participant will be subject to federal income tax in the year of distribution.
- Earnings on Roth contributions distributed from a 403(b) plan may be subject to an IRS 10% premature distribution penalty tax (unless an exception applies).
- Earnings on Roth contributions distributed from a governmental 457(b) plan are not subject to an IRS 10% premature distribution penalty tax.
- Earnings on Roth amounts rolled over from a 401(k) or 403(b) plan to a governmental 457(b) plan and then distributed from that 457(b) plan may be subject to the IRS 10% premature distribution penalty tax (unless an exception applies).
Roth amounts can stay in the plan until the participant decides to take a distribution.
As a general rule, a participant must begin taking distributions from their 403(b) and governmental 457(b) plans by April 1st of the calendar year following the later of the calendar year of (1) reaching the IRS required minimum distribution age or (2) retiring from the employer sponsoring the plan. The rationale behind this minimum distribution requirement is that amounts in the plan should be used during an individual’s retirement years, rather than accumulated under the plan account as an estate planning mechanism.
Due to recent federal tax law changes effective starting with the minimum distribution for calendar year 2024, Roth contributions and attributable earnings under a 403(b) plan or a governmental 457(b) plan are no longer subject to this minimum distribution rule during the participant’s lifetime. (After the participant’s death, their beneficiaries will be subject to these IRS minimum distribution requirements.) This gives a participant flexibility in deciding when to take a distribution of Roth amounts from the plan.
What else should a participant consider?
- Confirm whether the school district’s 403(b) and/or 457(b) plans permit Roth contributions.
- Identify the percentage or dollar amount of Roth contributions to be made to those plan(s). Remember that the total of pre-tax deferrals and Roth contributions cannot exceed the IRS annual deferral limit ($24,500 in 2026 before any applicable catch-up contributions).
- Update the salary reduction agreement under those plan(s). Remember, an election to make Roth contributions is irrevocable -- amounts contributed as Roth contributions to the plan cannot be recharacterized as pre-tax contributions.
- Discuss your tax planning strategy with your tax advisor.
Linda Segal Blinn, J.D.*, is assistant vice president of Technical Services for Tax-Exempt Markets at Voya Financial. In this capacity, Blinn leverages over 30 years of experience administering and designing defined contribution plans to provide general legislative and regulatory information to assist public and non-profit employers in operating their retirement plans.
This material was created to provide accurate information on the subjects covered. It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation. These materials are not intended to be used to avoid tax penalties, and were prepared to support the promotion or marketing of the matters addressed in this document. The taxpayer should seek advice from an independent tax advisor.
* Linda is not a practicing attorney for Voya Financial.