Last year, the SECURE 2.0 Act substantially changed retirement account rules. Some of these changes have already taken effect and caused confusion. That’s been problematic for some older adults who need clarity on crucial retirement planning aspects, such as when to take required minimum distributions (RMDs).
Another concern involved upcoming changes to rules governing catch-up contributions for 401(k) plans. These changes, which initially weren't going to be effective until 2024, will require catch-up contributions for higher-income earners to be made on a Roth basis.
Making catch-up contributions on an after-tax Roth basis means paying taxes on your retirement savings during the years when you usually earn more. On the other hand, traditional 401(k) accounts allow you to defer taxes until retirement, which can be advantageous if you anticipate being in a lower tax bracket by then.
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401(k) Catch-up contribution changes
- Under SECURE 2.0, if you are at least 50 years old and earned $145,000 or more in the previous year, you can make catch-up contributions to your employer-sponsored 401(k) account.
- But there’s a catch. You would have to make those extra contributions on a Roth basis, using after-tax money.
- You wouldn’t be able to get tax deductions on those catch-up contributions as you would with typical 401(k) contributions, but you could withdraw the money tax-free when you retire.
- The SECURE 2.0 Roth catch-up contribution rule won’t apply to taxpayers making $144,999 or less in a tax year.
What’s the problem? Essentially, when lawmakers drafted the Roth catch-up contribution provisions of SECURE 2.0, certain language was inadvertently left out of the law. As a result, according to the current text of SECURE 2.0, no participant would be able to make catch-up contributions (whether on a pre-tax or Roth basis).
Congress is aware of this and other drafting errors in SECURE 2.0, and lawmakers will likely make technical corrections. However, the mistake complicated challenges with implementing the catch-up contribution change that, until recently, was supposed to be effective next year.
Major companies advocated for 401(k) catch-up relief
Numerous employers plan providers, and organizations requested more time to modify systems to allow catch-up 401(k) contributions to be made on an after-tax basis. Over 200 entities made up of Fortune 500 companies, firms, and public employers, including the American Retirement Association, Chipotle Mexican Grill, Fidelity Investments, Charles Schwab, Microsoft Corporation, and Delta Airlines, asked for a two-year delay to the Roth catch-up rule to 2026.
“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 groups said in a letter to leaders of the U.S. House Ways and Means Committee, written by the American Benefits Council.
The group argued that the required systems for enforcing the rule, which they say involves “coordinating payroll systems instantly,” do not currently exist. "Obviously, any new rule requires new administrative work to implement," the letter says.
- Implementing a Roth feature for employer-sponsored 401(k) plans would also need to be added and communicated to all participants.
- The letter also mentions unique implementation obstacles faced by state and local governments and collectively bargained plans.
These organizations and companies further argued that if the U.S. Treasury Department or the IRS didn't provide relief, there might not be any catch-up contributions for next year.
Update: However, in late August, the IRS announced relief for high earners subject to the new Roth catch-up contributions rule, which is welcome news for many plan sponsors and employers who advocated for more implementation time. The agency says Roth catch-up contributions for high earners age 50 or over won’t be required until 2026. (That’s a two-year delay of the new rule.)
The IRS also clarified that plan participants aged 50 or older can make pre-tax catch-up contributions in 2023 despite their income level.
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