The SECURE 2.0 Act, which was passed in December 2022, brought about a significant change to the IRS catch-up contribution rules. This rule allows individuals aged 50 and above to contribute an additional $7,500 to an employer-sponsored pre-tax retirement plan.
However, SECURE 2.0 introduced a new twist by tying this catch-up contribution to income levels. According to the new regulation, those earning $145,000 and above are required to make this contribution to a Roth account with after-tax dollars.
Roth accounts are a valuable tool in retirement planning, helping to manage taxable income during retirement. Yet, losing the tax deduction on catch-up contributions, which had previously been made with pre-tax dollars, marked a substantial change.
Additionally, employers were affected by the new rules, which required them to offer Roth plans in addition to standard pre-tax plans. The change was scheduled to take effect in 2024, causing considerable concern among employers and plan providers, as they worried about setting up the required plans in time.
The legislation also contained a flaw in the language, discovered by the American Retirement Association, that would have eliminated all catch-up contributions, including both pre-tax and Roth, starting in 2024.
Now, the IRS has issued new guidance to address these issues, providing a clearer path forward.
What's New?
Individuals aged 50 and above can continue to make catch-up contributions beyond 2023, regardless of their income level. This ensures that those planning for retirement have flexibility in their contributions.
The IRS also addressed the change to Section 603 of the SECURE 2.0 Act, which mandated that beginning in 2024, a new Roth catch-up contribution rule would apply to an employee who participates in a 401(k), 403(b) or governmental 457(b) plan and whose prior-year Social Security wages exceeded $145,000
The rule was left in place, but an administrative transition period that extends through 2025 was announced. The transition period was enacted to help taxpayers have a smooth transition to the loss of the tax deduction and change to saving in a Roth account, and to help companies comply with the new requirement.
This means that pre-tax catch-up contributions are allowed even for those making $145,000 and over until 2026.
Lastly, the IRS also confirmed that the new Roth provision applies only to Social Security, or FICA, wages. Those who are self-employed do not receive FICA wages, and the requirement does not apply to them.
What Does This Mean for Your Retirement Strategy?
If you haven't been making catch-up contributions but are eligible at age 50 and above, it's a prudent move to consider. In 2023, the standard contribution limit is $22,500. By adding the pre-tax contribution of $7,500, you can contribute a total of $30,000. This represents a substantial investment opportunity, particularly in the later years of your working life as retirement approaches. While you'll pay taxes when withdrawing these funds in retirement, the additional time and funds invested can substantially boost your retirement savings. The contribution also lowers your taxable income in the year in which it is made, which can help with tax planning.
What Happens in 2026?
Roth accounts allow you to put money away with after-tax dollars. Because you’ve already paid the taxes, when you withdraw money in retirement, no more taxes are due. This allows the account to grow tax-free.
Your taxable income becomes very important once you are retired, claiming Social Security, and relying on Medicare for your health insurance. The goal is to keep taxable income low enough to avoid taxation on Social Security and the IRMAA surcharge on Medicare Part B and Part D payments.
This is where the advantage of Roth accounts comes in and is one reason why many people convert traditional retirement balances to a Roth account when they retire.
Making the catch-up to a Roth account may require some additional tax planning to account for an increase in taxable income, but the retirement savings aspect of the catch-up remains intact.
The Bottom Line: Boost your Retirement Plan
Retirement planning can be complex, and these recent changes might just be the motivation you need to establish a Roth account and fine-tune your retirement strategy. If you haven't been making catch-up contributions already, it's worth considering initiating them now, especially while you still have two more pre-tax years to capitalize on this opportunity before the new requirement takes effect.
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