The New Employer 401k Match Rule You Should Know About

Hello everyone, Kevin Jr here.

We spend a significant amount of time discussing the nuances of financial planning, and quite often, the conversation centers on what you, as the saver, are doing with your own capital. We talk about contribution limits, asset allocation, and the perennial debate between funding a traditional pre-tax 401(k) versus a Roth 401(k). These are the variables within your immediate control.

However, an interesting shift has occurred regarding the capital that comes from the other side of the table: your employer’s contribution.

For decades, the rules regarding employer matching were rigid. If your company offered a 401(k) match, that money was treated exclusively as pre-tax funds. It did not matter how you structured your own contributions. You could have been the most ardent supporter of the Roth philosophy, directing 100% of your salary deferrals into the Roth side of your plan, paying the taxes upfront to secure tax-free withdrawals later. Yet, when your employer dropped their matching percentage into your account, it invariably landed in the pre-tax category.

This created a mandatory bifurcation of your assets. You ended up with a mix of tax treatments by default, not necessarily by design. But recently, the regulatory landscape shifted.

The Rules Have Changed

With the passing of the SECURE 2.0 Act, Congress introduced a suite of changes aimed at modernizing the retirement system. While many of these provisions are technical and administrative, one specific change has direct, tangible implications for how you accumulate wealth.

Under Section 604 of the SECURE 2.0 Act, employers now have the option to allow employees to elect for their matching contributions to be treated as Roth contributions.

This is a fundamental departure from the previous standard. It means that for the first time, you have the potential to align the tax treatment of your employer’s capital with your own tax strategy. The compulsory separation of your contributions (Roth) and your employer’s contributions (pre-tax) is no longer a federal requirement. If your plan sponsor adopts this provision, the entirety of the inflow into your 401(k)—both your portion and the company match—can be designated as Roth.

This sounds like a minor administrative tweak, but in the context of long-term compounding and tax planning, it represents a significant opportunity for tax diversification. However, as with most financial decisions, this new flexibility comes with a distinct trade-off that requires careful analysis.

Pre-Tax or Roth Match: Which Side of the Fence Should You Be On?

Before we unpack the financial mechanics, we need to address the logistical reality. Just because the legislation allows for this change does not mean it is automatically active in your specific retirement plan.

The Question You Must Ask

Your immediate action item is to determine if your employer has updated their plan document to allow for this election. The adoption of SECURE 2.0 provisions is happening on a rolling basis, and payroll providers and recordkeepers are still updating their systems to accommodate the complex reporting requirements.

You should log into your 401(k) participant portal or draft an email to your benefits coordinator. You are looking for a specific election option, often labeled "Employer Match Tax Treatment," "Roth Employer Contribution," or something similar.

If the option is not there, ask if and when they plan to implement it. If it is there, do not simply click the box without understanding the bill that comes with it.

The Wealth Manager Analysis

This is where we need to move past the headline and look at the actual accounting. It is easy to see the word "Roth" and assume "tax-free is better." While tax-free growth is a powerful vehicle, we must look at the cost of entry.

The Cost: Immediate Taxation

The most critical component to understand is that employer contributions designated as Roth are includible in your gross income for the year in which the contribution is made.

In the old system, the employer match was "pre-tax," meaning it was excluded from your taxable income for the current year. You paid zero taxes on that money when it went in, and you only dealt with the IRS when you withdrew the funds in retirement.

If you elect the Roth match, that exclusion disappears.

Let’s look at a practical example to clarify the math. Suppose you earn a salary of $100,000. Your employer offers a generous match, and over the course of the year, they contribute $5,000 to your 401(k).

If you stick with the traditional pre-tax match, your taxable income regarding these funds remains $100,000. The $5,000 sits in the retirement account, untaxed for now.

However, if you elect the Roth match, that $5,000 is treated as if it were paid to you in cash and then deposited into the account. Consequently, your taxable income for the year rises to $105,000. You will owe federal and state income tax on that extra $5,000 in the current tax year, even though you never saw that money land in your checking account.

This creates a cash flow consideration. Since the 401(k) system generally cannot withhold taxes from the employer match itself, you may find yourself with a higher tax bill in April or needing to adjust your withholding on your W-4 to account for the increased taxable income. You are essentially paying a premium today for a benefit you will not access for decades.

The Benefit: Tax-Free Growth and Withdrawal

Why would anyone volunteer to pay more taxes today? The answer lies in the power of compounding without a future tax liability.

When that $5,000 goes into the Roth account, it has cleared its tax hurdle. If that money sits in the market for twenty or thirty years, it will ideally grow significantly. In a pre-tax account, every dollar of that growth is subject to ordinary income tax upon withdrawal. If tax rates are higher in the future, that liability could be substantial.

In the Roth account, the growth is tax-free. If that $5,000 grows to $20,000 over time, the entire $20,000 is yours to keep. The IRS has no claim on the earnings. For those who believe their tax rate is lower today than it will be in retirement, paying the tax on the seed (the contribution) to avoid the tax on the crop (the earnings) is a mathematically sound strategy.

The Hidden Benefit: RMD Changes

There is another layer to this that is particularly relevant for those looking at legacy planning.

Historically, Roth 401(k)s were subject to Required Minimum Distributions (RMDs). This meant that even though the money was tax-free, the government forced you to start taking it out of the account once you reached a certain age. This forced withdrawal often complicated estate planning or increased the provisional income used to calculate Medicare premiums.

However, another provision of SECURE 2.0 has aligned Roth 401(k) rules with Roth IRA rules. Starting in 2024, Roth 401(k) accounts are no longer subject to RMDs during the original owner's lifetime.

This is a massive shift. It means that if you choose the Roth match, that capital can sit in your account, compounding tax-free, for your entire life. You are not forced to liquidate it if you do not need the income. This makes the Roth 401(k) match a highly effective tool for wealth transfer, allowing you to pass on a tax-free asset to your beneficiaries.

Conclusion: A Strategic Decision

The ability to categorize employer matching funds as Roth is a welcome evolution in the retirement planning landscape. It offers greater control and the ability to minimize future tax uncertainty. However, it is not a one-size-fits-all solution.

For some, specifically those in their peak earning years where current marginal tax rates are high, adding more taxable income today might not make sense. For others, particularly those early in their careers or those who anticipate a significant rise in future tax rates, paying the tax now could result in substantial savings later.

We always encourage you to look at these decisions not in a vacuum, but as part of a broader comprehensive plan. Check your plan documents, run the numbers on what the extra tax liability looks like for this year, and determine if the long-term tax freedom is worth the short-term cost.

If you are unsure how this integrates with your current strategy, or if you just want to verify what your plan allows, we are here to help you walk through the options.

Best,

Kevin Jr.