The IRS recently announced some welcome news for higher-income workers with 401(k)s and similar retirement plans. The agency delayed implementing a new rule that would have required catch-up contributions made by people earning over $145,000 to be directed into an after-tax Roth account.
The rule change was originally set to start in 2024, but will now be postponed until 2026 thanks to the new two-year administrative transition period. This gives savers who are both nearing retirement and earning over $145,000 two additional years to make catch-up contributions on a pre-tax basis.
A financial advisor can review your retirement plan and provide recommendations for the future. Speak with an advisor today.
Why the IRS Announced This
The Roth catch-up requirement is a part of the SECURE Act 2.0 signed into law in late 2022. A provision of the legislation mandated that starting in 2024, any catch-up contributions made to a 401(k) or similar workplace retirement account by someone earning over $145,000 in the prior year must be made on a Roth basis. With Roth contributions, you pay taxes on the money upfront in exchange for tax-free growth and withdrawals.
In a separate issue, the authors of the legislation mistakenly deleted the provision allowing any and all catch-up contributions for savers at every income level. As written and enacted into law, this error meant the end of catch-up contributions entirely after 2023. Congress had acknowledged the oversight, but has yet to pass correcting legislation to restore catch-ups.
Then the IRS stepped in. The agency essentially indicated it wasn’t waiting for a legislative fix. Instead, it will act as though the glitch never happened. In short, as far as the IRS is concerned, catch-up contributions can continue as before in 2024 and beyond, no matter what the language of the law says.
“The notice also clarifies that the SECURE 2.0 Act does not prohibit plans from permitting catch-up contributions, so plan participants who are age 50 and over can still make catch-up contributions after 2023,” the IRS stated in its announcement.
How This Impacts Retirement Savers
The accidental removal of catch-up contributions could have had significant implications for anyone over 50 and nearing retirement. Catch-up contributions allow people 50 and over to make extra 401(k) contributions above the regular annual limits, turbocharging savings in the crucial years before retirement. This could have left some retirement nest eggs short of the amount needed for a comfortable and secure retirement.
The burden posed by the Roth requirement for catch-up contributions for higher earners loomed somewhat less large. This change would have forced savers to immediately pay taxes on catch-up contributions rather than putting the funds away pre-tax.
Roth accounts generally provide the potential for significantly greater returns on retirement investments. That’s because withdrawals are free of income taxes. However, when savers can’t defer taxes on contributions, it can increase taxable income in the here and now. Worst case, this can push them into a higher marginal tax bracket.
Employers faced a more significant and certain burden as well. That’s because employer-sponsored retirement plans without Roth plans would have had only months to add them to accommodate catch-ups for employees earning at least $145,000. Their loud complaints about this nuisance provided a strong impetus for the IRS to act by creating this transition period.
Bottom Line
Thanks to IRS transitional relief, retirement savers have more flexibility with their catch-up contributions until 2026. They can also breathe easier thanks to the agency’s announcement that it will essentially disregard an error in the SECURE Act 2.0 of 2022 that would have eliminated all catch-up contributions altogether starting in 2024.
Here are some ways you may be able to take advantage this change:
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If you’re 50 or older, take advantage of two more years of pre-tax catch-up contributions to lower your taxable income before the Roth rule kicks in.
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If you can afford it, use the delay to direct some catch-up dollars to a Roth voluntarily to hedge your bets.
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Develop a plan for 2026 and beyond when catch-ups must be done on a Roth basis.
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Speak with a financial advisor about how to account for this in your retirement plan.
Retirement Planning Tips
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Your income, employer matches, taxes and other factors work together to affect how your 401(k) grows. SmartAsset’s 401(k) calculator cuts through the complexity to project how much you’ll have when it’s time to retire.
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Confused about catch-up contributions and income limits? A financial advisor can help, and finding one doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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The post Good News for People Who Make $145K: IRS Delays New Catch-Up Contribution Rule Until 2026 appeared first on SmartReads by SmartAsset.
Source: finance.yahoo.com