The SECURE 2.0 Act, introduced last year, significantly altered retirement account regulations. Some modifications have already been implemented, leading to confusion, especially among older individuals trying to navigate essential retirement planning decisions, like when to take required minimum distributions (RMDs).
A particular area of concern is the forthcoming adjustments to the rules surrounding catch-up contributions for 401(k) plans. Initially set to be effective in 2024, these changes will necessitate catch-up contributions for those with higher incomes to be made on a Roth basis. This shift implies that individuals must pay taxes on their retirement savings during their peak earning years. In contrast, traditional 401(k) accounts let contributors defer these taxes until retirement, which can be beneficial if one expects to be in a lower tax bracket upon retiring.
Key Changes in 401(k) Catch-Up Contributions:
- As per SECURE 2.0, individuals aged 50 and above who earned $145,000 or more in the preceding year can make catch-up contributions to their employer-sponsored 401(k) account.
- However, these additional contributions must be made on a Roth basis using post-tax funds.
- While these catch-up contributions won’t be tax-deductible like regular 401(k) contributions, they can be withdrawn tax-free during retirement.
- This Roth catch-up contribution rule of SECURE 2.0 won’t apply to those earning $144,999 or less in a tax year.
A significant issue arose when the Roth catch-up contribution provisions of SECURE 2.0 were being drafted. Due to an oversight, certain essential language was omitted from the legislation. Consequently, per the current wording of SECURE 2.0, no participant would be eligible to make catch-up contributions, whether on a pre-tax or Roth basis. Congress has recognized this and other errors in the act and is expected to make the necessary corrections. This oversight added to the complexities of implementing the catch-up contribution change.
Advocacy for 401(k) Catch-Up Relief:
Many major companies, employers, and organizations called for an extension to adjust their systems to accommodate catch-up 401(k) contributions on a post-tax basis. Over 200 entities, including Fortune 500 companies like Microsoft, Delta Airlines, and others such as Fidelity Investments and Charles Schwab, sought a two-year postponement of the Roth catch-up rule to 2026. They emphasized that without immediate transitional relief, many retirement plan participants would lose the opportunity to make catch-up contributions by the end of the year.
They also pointed out that the necessary systems for enforcing the rule, which would involve real-time payroll system coordination, are not yet in place. Additionally, introducing a Roth feature for employer-sponsored 401(k) plans would require extensive communication with all participants.
These entities further warned that catch-up contributions might be entirely unavailable for the upcoming year without intervention from the U.S. Treasury Department or the IRS. As part of a recent update, the IRS has provided relief to high earners affected by the new Roth catch-up contributions rule.
This relief was a response to the many plan sponsors and employers advocating for more time for implementation. The IRS has now stated that Roth catch-up contributions for high earners aged 50 or above will not be mandatory until 2026. Furthermore, they clarified that in 2024, plan participants aged 50 or older can make pre-tax catch-up contributions regardless of their income level.