High Earners 50-And-Older Get 2-Year Break On 401(k) Catch-Up Rule

The Internal Revenue Service on Friday announced that it would postpone enforcement of a law that would require high-earners to exclusively allocate “catch-up” contributions to Roth-style investment accounts — rather than pre-tax accounts that confer an immediate income tax benefit.  

The change in the law, inflicted by December 2022’s SECURE 2.0 Act, stipulated that, starting in 2024, 401(k) participants making catch-up contributions by virtue of being age 50 or older must put those contributions in Roth accounts if their prior-year Social Security wages were more than $145,000. Friday’s announcement means people fitting that description can allocate catch-up contributions to pre-tax accounts for another two years.  

Unlike traditional pre-tax contributions, Roth contributions do not reduce a participant’s current-year taxable income and thus don’t provide immediate tax relief. The Roth payoff comes later, as qualified distributions are income-tax-free. Conversely, pre-tax contributions are full taxable when distributed. 

Some higher earners anticipate being in a lower tax bracket when they start tapping their 401(k) in retirement, compared to the bracket they’re in today. That means they’re more enthused about reaping current-tax-year savings from pre-tax contributions rather than the tax-free treatment in retirement. 

For 2023, the regular 401(k) contribution limit is $22,500. Participants who are 50 and older can contribute another $7,500 in catch-up contributions, for a total of $30,000. Vanguard says 16% of eligible participants made catch-up contributions in 2022.  

A participant in the 35% tax bracket can cut his income tax bill an extra $2,625 by making a $7,500 pre-tax, catch-up contribution — in addition to tax savings from the other regular contribution.  

“The administrative transition period will help taxpayers transition smoothly to the new Roth catch-up requirement and is designed to facilitate an orderly transition for compliance with that requirement,” the IRS said. The widely-despised instrument of government theft also clarified that the SECURE 2.0 Act doesn’t bar anyone from making catch-up contributions, regardless of income, in 2023 or beyond. Some feared a textual error had accidentally banned catch-up contributions altogether.  

The new and now-postponed rule about catch-up contributions only applies to 401(k) and similar accounts, not to Individual Retirement Accounts (IRAs). 

Given the uncertainty of future tax rates — imposed by a government that’s hurtling toward insolvency — many advisors say it’s a good idea to diversify the tax flavor of your retirement accounts. Having a substantial bucket of Roth money provides flexibility in managing your tax bills in retirement…assuming Uncle Sam doesn’t pull a Darth Vader and “alter the deal” by revoking the tax-free treatment for “wealthy” Americans.