Shocking Revelation: High-Income Savers Must Pay Taxes NOW on Retirement Contributions

Tags: retirement savers, catch-up contributions, taxes, Congress, Secure Act 2.0, retirement accounts, Roth basis, after-tax money, tax deduction, retirement planning, contribution limits, 401(k), retirement plans, Vanguard report, legislative errors, operational challenges, retirement community, retirement savings, Roth accounts, required minimum distributions, IRS, U.S. Treasury, American Retirement Association, 

Retirement savers with high incomes might soon face the prospect of paying taxes immediately on catch-up contributions rather than later. Congress passed Secure Act 2.0 last December, stipulating that certain older Americans, who are at least 50 years old and earned over $145,000 in the prior year, must make catch-up contributions to their 401(k) on a Roth basis using after-tax money. As a result, these individuals won’t be able to deduct the contribution amount, which can be up to an additional $7,500 for the year 2024. However, they can withdraw the money tax-free during their retirement.

The planned change, set to take effect in 2024, is facing a number of obstacles that may cause delays in its implementation. These issues range from legislative errors to operational complexities and even debates about the government’s role in dictating retirement savings strategies. Consequently, there are uncertainties regarding the effectiveness of this law in achieving its intended purpose.

The catch-up contribution change affects only those who earned $145,000 or more in wages in the prior year at their company. Even though individuals can still add to their retirement plan provided by their employer, they are now required to pay taxes on the catch-up amount before contributing it to a Roth account, where it will then grow tax-free.

According to a Vanguard report based on numerous retirement plans, approximately 16% of eligible employees took advantage of catch-up contributions in 2024.

There are three main issues that have arisen with the new law:

  1. A paragraph was accidentally deleted during the rush to pass the legislation, making catch-up contributions technically illegal. Congress is aware of this oversight and is expected to correct it.
  2. The details of how the law will function remain unclear, leading the American Retirement Association (ARA) and other parties to request a two-year delay. In order to offer a Roth 401(k) option, some plans may require guidance from regulatory bodies and approval from legislative or union authorities.
  3. The government’s mandate on retirement savings has sparked debate, especially regarding the Roth catch-up contribution. This contribution requires individuals to pay taxes during high-earning years instead of waiting for potentially lower-tax retirement years.

Millions of Americans might lose the chance to make catch-up contributions in the next year if Congress doesn’t take action on time. The ARA suggests that the IRS and U.S. Treasury can provide relief by waiving taxes, interest, penalties, or sanctions for noncompliance with the new Roth catch-up contribution rule until January 1, 2026.

The implementation of Secure Act 2.0’s catch-up contribution changes is facing significant challenges overall. If these issues are not resolved quickly, retirement savers may miss valuable opportunities to increase their retirement savings.