Tax Break Vanishing for Some Retirement Savers
A popular tax break in the form of being able to make so-called “catch-up” contributions to 401(k) retirement savings plans is set to vanish for many higher-earning Americans at the end of this year.
Catch-up contributions refer to a provision in 401(k) plans that allows individuals aged 50 and above to contribute extra money to their retirement savings accounts. The aim of catch-up contributions is to enable older workers to accelerate their retirement savings in the years leading up to their retirement.
This year, eligible workers aged 50 and over can put an extra $7,500 into their 401(k) accounts, for a total of $30,000. But starting next year, there are changes that limit this eligibility for higher earners.
Changes to Catch-Up Contributions
Changes introduced by the SECURE 2.0 Act that cleared Congress late last year and was signed into law by President Joe Biden change the rules around catch-up contributions.
Specifically, people who earned over $145,000 last year will no longer be able to make catch-up contributions to their 401(k) accounts. Instead, they will only be able to funnel those funds only into after-tax Roth accounts.
The significance of this change is that such higher-earning Americans will end up having to pay taxes on their catch-up contributions up front, in years where they’re typically in a higher tax bracket than when retired.
Traditional 401(k) accounts are funded with pretax earnings and withdrawals are taxed once savers enter retirement. Roth accounts, by contrast, are funded with aftertax dollars, with subsequent withdrawals being tax-free.
The change goes into effect for tax years starting Dec. 31, 2023.
Request for Delay
A number of employers, retirement plan providers, and others have asked Congress to adopt a delay in the implementation of the new rule that limits eligibility for 401(k) catch-up contributions for higher earners.
In a June 29 letter (pdf) to the House Ways and Means Committee, a coalition of over 100 signatories—including Charles Schwab, the National Association of State Retirement Administrators, and Verizon—have called for a two-year delay in implementing the new Roth catch-up rule.
The letter cites an inability on the part of many signatories to adapt their systems to ensure that catch-up contributions to be made on a Roth basis for those earning over $145,000 in the preceding year.
“Unless transition relief is granted as soon as possible, many retirement plan participants will lose the ability to make catch-up contributions at the end of this year,” the signatories wrote.
“For many of these plans, unless this requirement is delayed very quickly (i.e., this summer), their only means of compliance will be to eliminate all catch-up contributions for 2024,” they continued.
The reason is that, for the most part, the signatories lack arrangements that coordinate retirement plan recordkeeping with payroll systems (which determine who earned over $145,000 in the prior year.
“These circumstances pose a long list of other obstacles including, for many plans, the challenges of adding a Roth feature and communicating that feature to participants, as well as special challenges for state and local governments and collectively bargained plans,” the signatories wrote.
The call is for Congress to pass legislation to provide the two-year delay to allow employers and plan providers to adapt their systems. However, failing congressional action, the signatories said that the Internal Revenue Service (IRS) and the Department of the Treasury have the authority to provide the requested relief unilaterally.
For example, the IRS could announce that it won’t seek any penalties or sanctions for non-compliance with the Roth catch-up rule prior to Jan. 1, 2026.
The Treasury Department did not immediately respond with a request for comment on whether it is considering unilateral action to grant a two-year delay, as requested by the groups.
Other Changes Under SECURE 2.0
There are a number of other changes introduced by the SECURE 2.0 legislation.
One change is that the age at which people are required to start taking minimum distributions from their retirement accounts has changed. Under the SECURE 2.0 Act, the new minimum distribution age is 73 for those who turn 72 after Dec. 31, 2022, and 75 for those who turn 74 after Dec. 31, 2032.
However, if someone is already due to take their first distribution by April 1, 2023, these changes won’t affect them. The act also reduced the penalty for not taking the required distribution from 50 percent to 25 percent, starting from Dec. 29, 2022.
The SECURE 2.0 Act also permits employers to count qualified student loan repayments as employee contributions to retirement plans, even if the employee isn’t making regular contributions. This allows employers to match these repayments with contributions to the retirement plan.
Under the SECURE 2.0 Act, individuals can now withdraw up to $1,000 from their retirement accounts for unforeseeable and immediate personal emergency expenses. The plan administrator relies on the employee’s certification that the emergency meets the required criteria for the withdrawal.
Another change is that, starting in 2025, part-time employees will be able to participate in workplace retirement plans sooner. Previously, they had to work at least 500 hours for three consecutive years to be eligible, but now they only need to work 500 hours for two consecutive years to qualify.
