In a recent development, the Internal Revenue Service (IRS) has revealed that individuals with high incomes will be granted an extension until 2026 to make catch-up contributions into Roth accounts, as outlined in the Secure 2.0 bill enacted at the close of 2022. The delay aims to allow ample time for the resolution of intricate details surrounding this provision. The announcement comes as part of a new notice issued by the IRS.
One noteworthy aspect of the Secure 2.0 bill, which was initially hailed as a comprehensive package of various benefits, was the stipulation that high earners’ catch-up contributions must be directed to Roth accounts. However, this requirement has now been postponed by two years to ensure a smoother implementation process and to clarify certain ambiguities.
Furthermore, it has come to light that a section of the bill’s text that appeared to terminate catch-up contributions for all individuals after 2024 was, in fact, an error and will not be upheld.
For individuals aged 50 and above with earnings exceeding $145,000, this delay offers a welcome window of opportunity to adjust their financial strategies. The primary impact of this extension will be felt by employers, granting them additional time to integrate Roth 401(k) features into their retirement plans if such provisions were not previously available.
However, it is important to note that the deferment of catch-up contributions does not signify that retirement savers are compelled to postpone their actions. Those whose employers offer Roth 401(k) options within their retirement plans can readily opt to allocate their catch-up contributions towards these accounts. Doing so could potentially yield long-term benefits for the contributors.
The concept of catch-up contributions, designed to allow individuals to make larger contributions to their retirement funds as they near retirement age, is still relatively underutilized. Even considering the standard annual 401(k) contribution limits, only a modest 15% of individuals with 401(k) plans manage to reach the maximum contribution cap, set at $22,500 in 2023. While this year permits an additional catch-up contribution of $7,500 for those aged 50 and above, a mere 16% of eligible individuals typically take advantage of this option.
The Secure 2.0 amendment will mandate high earners, those earning over $145,000, to channel their catch-up contributions into Roth 401(k) accounts. It’s worth noting that this category largely comprises those who already engage in catch-up contributions. A recent study by Vanguard revealed that 58% of individuals making catch-up contributions earn more than $150,000.
The Advantages of the Roth Approach
Opting for a Roth 401(k) involves having contributions taxed as regular income for the current year, with subsequent tax-free growth for retirement. In contrast, a traditional 401(k) follows a different model, with funds entering the account prior to taxation, experiencing tax-deferred growth, and being subject to taxation upon withdrawal during retirement.
While opinions vary regarding the optimal tax strategy, the Roth option could be particularly favorable for individuals aged 50 and above with earnings surpassing $145,000. Maria Bruno, Head of U.S. Wealth-Planning Research at Vanguard, emphasizes the benefit of “tax diversification” inherent in the Roth approach.
This preference for Roth accounts is underscored by the limitations imposed by traditional 401(k) plans, which necessitate withdrawals upon reaching a specific age. This age, presently set at 73 and slated to increase to 75 in the coming decade, introduces required minimum distributions (RMDs) for tax-deferred accounts. The Secure 2.0 amendment accentuates the significance of RMDs for high earners, prompting them to consider transferring funds to Roth accounts, which evade distribution requirements and offer advantages for beneficiaries.
Understanding the Tax Implications
A practical perspective on tax implications reveals that directing an additional $7,500 catch-up contribution into a Roth 401(k) would lead to approximately $70 more in taxes per paycheck for individuals within the 24% tax bracket. Deferring these taxes until age 75 could see this contribution grow to $25,000, subject to taxation at the prevailing rate.
In essence, it’s crucial to recognize that evading taxes on retirement savings is a temporary endeavor, and eventual government regulations are inevitable.
This has prompted numerous high earners to actively seek Roth alternatives. Over their careers, they accumulate funds in traditional 401(k)s and other tax-deferred accounts. Upon retirement, they explore methods such as Roth conversions and mega-backdoor Roths to access these funds. However, a simpler approach lies in contributing directly to Roth 401(k) plans, an option widely available through employers.
Lawrence Spring, a certified financial planner and founder of Mitlin Financial, emphasizes that the unfamiliarity with this approach often leads to financial challenges during retirement. Many individuals amass substantial sums in tax-deferred accounts, inadvertently placing themselves in higher tax brackets upon withdrawal.
In conclusion, the IRS’s announcement of a delay in high earners’ catch-up contributions to Roth accounts until 2026 provides an opportunity for strategic planning. While the delay may benefit some, individuals are encouraged to consider the potential advantages of Roth contributions within their retirement plans, particularly for those aged 50 and above with earnings exceeding $145,000.
Disclaimer: The views, suggestions, and opinions expressed here are the sole responsibility of the experts. No Daily Insight 360 journalist was involved in the writing and production of this article.
