Tax Break Vanishing for Some Retirement Savers

A sheet of uncut $100 bills is inspected during the printing process at the Bureau of Engraving and Printing Western Currency Facility in Fort Worth, Texas, on Sept. 24, 2013. (LM Otero/AP Photo)

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 older 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 older can put an extra $7,500 into their 401(k) accounts, for a total of $30,000. But starting next year, changes will limit that eligibility for higher earners.

Changes to Catch-Up Contributions

The SECURE 2.0 Act, which cleared Congress late last year and was signed into law by President Joe Biden, changed the rules.

Specifically, people who earned more than $145,000 the previous year will no longer be able to make catch-up contributions to their 401(k) accounts. Instead, they'll only be able to funnel those funds into after-tax Roth IRA accounts.

The significance of this change is that those higher-earning Americans will end up having to pay taxes on their catch-up contributions up front, in years when they’re typically in a higher tax bracket than when they have retired.

Traditional 401(k) accounts are funded with pretax earnings, and withdrawals are taxed once savers enter retirement. Roth IRA accounts, by contrast, are funded by after-tax dollars, with subsequent withdrawals being tax-free.

Request for Delay

A number of employers, retirement plan providers, and others have asked Congress to delay 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 more than 100 signatories—including Charles Schwab, the National Association of State Retirement Administrators, and Verizon—has called for a two-year delay in implementing the new Roth IRA catch-up rule.

The letter cites an inability on the part of many signatories to adapt their systems to ensure that catch-up contributions will be made on a Roth IRA basis for those earning more than $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.”

The reason is that, for the most part, the signatories lack arrangements that coordinate retirement plan recordkeeping with payroll systems (which determine who earned more than $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 a two-year delay to allow employers and plan providers to adapt their systems. However, failing congressional action, the signatories said that the 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 noncompliance with the Roth catch-up rule prior to Jan. 1, 2026.

The Treasury Department didn’t immediately respond to a request for comment as to whether it’s considering unilateral action to grant a two-year delay, as requested by the groups.

Other Changes Under SECURE 2.0

The SECURE 2.0 legislation introduced a number of other changes, as well.

The legislation changed the age at which people are required to start taking minimum distributions from their retirement accounts. 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, 2033.

However, if someone is already qualified 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 to 25 percent from 50 percent, starting 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 in order to be eligible; now they need to work only 500 hours for two consecutive years to qualify.