The Internal Revenue Service has postponed the start date of a new rule that requires high-income earners’ catch-up 401(k) contributions to be deposited into Roth accounts on an after-tax rather than pre-tax basis.
Originally scheduled to come into force next year, the changes made under last December’s Secure Act 2.0 have been postponed to 2026.
Here’s what you should know about this change:
What are the current rules?
Participants in similar Employer Retirement Plans, including 401(k) and 403(b) and 457(b), over age 50, are permitted to make catch-up contributions in addition to their annual contribution limits .
This year’s 401(k) contribution limit is $22,500. People over the age of 50 can also donate $7,500 to receive a total of $30,000. Contributions to 401(k) and similar employer plans are generally made on a pre-tax basis, so the funds saved reduce your annual taxable income. The trade-off for this tax reduction is that assets drawn from your 401(k) will be taxed at the income tax rate.
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401(k) and similar retirement account assets must be held until age 59½, or a 10% penalty will be imposed.
How will this change?
Secure Act 2.0 requires catch-up contributions by people who earned $145,000 or more in the previous year to be made on an after-tax basis to a Roth account in a 401(k).
Pre-tax contributions are still permitted up to the standard annual 401(k) contribution limit, but high-income earners must pay taxes upfront on catch-up contributions. 401(k)s Roth account assets (both principal and accrual) can be withdrawn tax-free after age 59 1/2.
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What is the reason for this change?
If Congress passes tax cuts, it aims to offset the government’s revenue losses with profitable reforms. The Secure Act 2.0 contained a number of revenue-reducing provisions, including raising the required minimum distribution age, indexing the catch-up contribution to inflation, and other adjustments to encourage more retirement savings.
“This rule, which mandates after-tax catch-up contributions, will increase revenue. President Mark Friedrich said.
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“When Congress was looking for a source of income, it was favored because it aimed at wealthier individuals.”
Why did the IRS delay the rule change?
In July, the American Retirement Association and major retirement plan sponsors called for a delay in establishing after-tax loss deposits in more locations. While some 401(k) plans now offer a Roth option, many do not and face administrative challenges in complying with the new rules.
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What Happens During Delay?
Pre-tax catch-up contributions will be allowed in 2024 and 2025 before the new rules come into force.
Is Delay Good or Bad News for Wealthy Savers?
For many savers, the rule change is unwelcome and the delay is a reprieve, he said.
Michael Finke, Professor of Wealth Management at the American College of Financial Services. “People over the age of 50 are in their peak income period, which means they are in the highest marginal tax bracket,” says Finke. “If the pre-retirement tax rate will be higher than the post-retirement tax rate, then the old rule has more merit than using Roth.”
Upfront tax relief at high tax rates is usually better than no tax.
Retirement withdrawals with lower tax rates may be an option, especially if you have fewer years to grow your wealth between contributions and withdrawals.
But some people, on an after-tax basis,
Losses can mean more money in the long run. Income tax rates are set to increase in 2026 after tax cuts and employment provisions expire. Unless Congress extends the current income tax rate, the top rate will rise from 37% to 39.6%.
If I haven’t donated yet, do I need to make an additional donation?
yes. Most people don’t use catch-up donations. “In 2022, only his 16% of eligible employees will have such results,” says Friedrich. This means that the vast majority of savers miss out on the potential to greatly increase their nest eggs.
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how big is the boost?
It’s pretty big. Consider his two savers, each of whom is 49 years old and has $600,000 in his 401(k) savings. When they turn 50, only one person is eligible for catch-up contributions. According to T. Rowe Price’s chart, assuming an average annual rate of return of 7% and stable annual contributions, by age 65, savers who have collected make-up contributions outnumber savers who have not. He had $202,000 more money than he did from $2,462,061.
