The Secure 2.0 bill passed in late 2022 was such a big grab bag of extras that there were bound to be some issues. A major issue — the requirement for top earners to post catch-up contributions to Roth accounts — will be pushed back two years to 2026 to clarify the details, the IRS said in a new notice.
The agency also noted that a line in the text of the law that appeared to abolish catch-up contributions for everyone after 2024 was a mistake and will not be considered.
This gives people 50 and older who make more than $145,000 a little more time before they need to make changes. This is particularly affecting employers, who now have more time to add Roth 401(k) features to their plans if they haven’t already offered them.
But the two-year delay doesn’t mean pension savers have to wait if they don’t want to. If your employer’s pension plan offers a Roth 401(k) option, you can now easily allocate your catch-up contributions this way, which could potentially benefit you in the long term.
The catch with catch-up contributions is that not many people make them. Even the basic annual 401(k) contribution limits have always been a bit ambitious. According to Vanguard’s latest study, only 15% of workers with a 401(k) will pay the maximum, which will be $22,500 in 2023. This year’s catch-up contribution allows people 50 and older to contribute an additional $7,500, for a total of $30,000. Typically, however, only 16% of those eligible make a catch-up payment.
The Secure 2.0 change requires those earning more than $145,000 to put those catch-up contributions into a Roth 401(k). In most cases, those who earn that amount are the ones who make catch-up contributions at all. Vanguard’s study found that 58% of those who contributed an additional amount made over $150,000.
The advantages of a Roth
With a Roth 401(k), your contribution is taxed as regular income for the current year and then grows tax-free until retirement. With a traditional 401(k), it’s the other way around — the money goes into the account pre-tax and grows tax-deferred, and then it’s taxed when you withdraw it in retirement.
There is much debate as to which tax model is best, and the answer depends on an individual’s financial situation. But in general, for those who are 50 years or older and earn more than $145,000, the Roth option could be a good strategy. “That way, you get some tax diversification right away,” says Maria Bruno, Vanguard’s head of US wealth planning research.
That’s because the tax deferral of traditional 401(k) plans is time-limited: the IRS requires people over a certain age to start withdrawing money from these accounts. That age is currently 73 years old and will be 75 years old in a decade. It could be pushed even further outwards in the future.
For high earners, the required minimum distributions, so-called RMDs, play a major role. At some point, these hard-working savers will have to turn their attention to emptying those accounts in Roths that don’t have distribution obligations — and that are also cheaper for heirs.
If you’re in the 24% tax bracket, putting that additional $7,500 of catch-up contribution into a Roth 401(k) results in about $70 more tax per paycheck. If you defer those taxes until age 75, that contribution could increase to $25,000 and you will be required to pay the associated tax at your then applicable tax rate.
The bottom line is that you can’t avoid taxes on retirement savings forever, and at some point the government will dictate what you do.
In fact, many high earners are constantly looking for more Roth options. As their career progresses, they save money in traditional 401(k) or other tax-deferred savings accounts. As they reach retirement age, they look for ways to get money out of these accounts, such as Roth conversions and mega backdoor Roths. Instead, they could simply pay directly into a Roth 401(k) plan offered by most employers.
“People aren’t used to it, but then they get into trouble when they retire,” says Lawrence Spring, board-certified financial planner and founder of Mitlin Financial in Hauppauge, NY. “They put themselves in a higher tax bracket when they complete it.”