The Secure 2.0 bill enacted at the end of 2022 was such a huge grab bag of goodies that there were bound to be some hitches. One big one — the requirement that catch-up contributions for high earners must go into Roth accounts — is getting a two-year delay, until 2026, to sort out the details, the IRS announced in a new notice.
The agency also noted that a line in the bill’s text that seemed to eliminate catch-up contributions for everyone after 2024 was a mistake and wouldn’t be considered.
For people 50 and older who earn over $145,000, this allows some extra time before they have to make any changes. It mostly affects employers, who now have more time to add Roth 401(k) features to their plans, if they didn’t offer them already.
But the two-year delay does not mean retirement savers have to wait if they don’t want to. If your employer’s retirement plan offers a Roth 401(k) option, you can easily direct your catch-up contributions that way now, and it might benefit you in the long run.
The catch with catch-up contributions is that not many people make them. Even the baseline annual 401(k) contribution limits have always been somewhat aspirational. Vanguard’s latest study says only 15% of workers with a 401(k) contribute the maximum amount, which in 2023 is $22,500. This year’s catch-up contribution allows people 50 and older to put in an additional $7,500, for a total of $30,000, but typically only 16% of those eligible to do so will contribute any catch-up amount.
The Secure 2.0 change will require those who make more than $145,000 to put those catch-up contributions into a Roth 401(k). For the most part, people earning that amount are the ones who are making catch-up contributions in the first place. Vanguard’s study found that of those who do contribute any extra amount, 58% were making over $150,000.
The benefits of a Roth
With a Roth 401(k), your contribution is taxed as regular income for the current year, and then it grows tax-free for retirement. In a traditional 401(k), it’s the other way around — the money goes into the account before taxes and grows tax-deferred, and then it is taxed when you take it out in retirement.
There are all sorts of debates about which tax model is best, and the answer depends on a person’s financial situation. But in general, for those who are 50 or older and are making more than $145,000, the Roth option could be a good strategy. “That way you’re instantly getting some tax diversification,” says Maria Bruno, head of U.S. wealth-planning research at Vanguard.
That’s because the tax deferral of traditional 401(k) plans has a time limit: The IRS requires people to start taking money out of those accounts when they reach a certain age. That age is currently 73 and will be 75 in a decade. It could get pushed further out in the future.
For high earners, those required minimum distributions, known as RMDs, loom large. At some point, these diligent savers have to turn their attention to emptying those accounts into Roths, which have no distribution requirements — and are also more favorable to heirs.
If you’re in the 24% tax bracket, putting that additional $7,500 catch-up contribution into a Roth 401(k) will result in about $70 more in taxes per paycheck. If you defer those taxes until you’re 75, that contribution could grow to $25,000, and you’ll have to pay the tax on it at whatever rate applies to you then.
The bottom line is that you can’t avoid the taxes on retirement savings forever, and at some point, the government is going to dictate what you do.
In fact, many high earners are constantly looking for more Roth options. Over the course of their careers, they save money in traditional 401(k)s or other tax-deferred savings accounts. When they hit retirement age, they look for ways to get it out of those accounts, like Roth conversions and mega-backdoor Roths. Instead, they could just contribute directly into a Roth 401(k) plan, which is offered by most employers.
“People are not used to it, but then they are running into trouble at retirement age,” says Lawrence Spring, a certified financial planner and founder of Mitlin Financial in Hauppauge, N.Y. “They have so much money in tax-deferred money that they’re causing themselves to be in a higher tax bracket when they take it out.”