New rules governing certain 401(k) catch-up contributions are causing confusion and raising concerns.
Last year, the SECURE 2.0 Act substantially changed retirement account rules. Some of these changes have already taken effect and have caused confusion. That’s been problematic for some older adults who need clarity on crucial retirement planning aspects, such as when to take required minimum distributions (RMDs).
Another concern is the upcoming changes to the rules governing catch-up contributions for 401(k) plans. These changes, which won’t be effective until 2024, will require catch-up contributions for higher-income earners to be made on a Roth basis.
Making catch-up contributions on an after-tax Roth basis means paying taxes on your retirement savings during the years when you usually earn more. On the other hand, traditional 401(k) accounts allow you to defer taxes until retirement, which can be advantageous if you anticipate being in a lower tax bracket by then.
401(k) Catch-up contribution changes
- Under SECURE 2.0, if you are at least 50 years old and earned $145,000 or more in the previous year, you can make catch-up contributions to your employer-sponsored 401(k) account.
- But there’s a catch. You would have to make those extra contributions on a Roth basis, using after-tax money.
- You wouldn’t be able to get tax deductions on those catch-up contributions as you would with typical 401(k) contributions, but you could withdraw the money tax-free when you retire.
- The SECURE 2.0 Roth catch-up contribution rule won’t apply to taxpayers making $144,999 or less in a tax year.
After-Tax 401(k) Contributions: Pros and Cons
What’s the problem? Essentially, when lawmakers drafted the Roth catch-up contribution provisions of SECURE 2.0, certain language was inadvertently left out of the law. As a result, according to the current text of SECURE 2.0, no participant would be able to make catch-up contributions (whether on a pre-tax or Roth basis).
Congress is aware of this and other drafting errors in SECURE 2.0, and lawmakers will likely make technical corrections. However, the mistake complicates existing challenges with implementing the catch-up contribution change by 2024.
Major companies want 401(k) catch-up relief
Numerous employers, plan providers, and organizations have requested more time to modify systems to allow catch-up 401(k) contributions to be made on an after-tax basis. Over 200 entities made up of Fortune 500 companies, firms, and public employers, including the American Retirement Association, Chipotle Mexican Grill, Fidelity Investments, Charles Schwab, Microsoft Corporation, and Delta Airlines, are asking for a two-year delay to the Roth catch-up rule to 2026.
“Unless transition relief is granted as soon as possible, many retirement plan participants will lose the ability to make catch-up contributions at the end of this year,” the groups said in a July 14 letter to leaders of the U.S. House Ways and Means Committee, written by the American Benefits Council.
The group contends that the required systems for enforcing the rule, which they say involves “coordinating payroll systems instantly,” do not currently exist. “Obviously, any new rule requires new administrative work to implement,” the letter says.
- Implementing a Roth feature for employer-sponsored 401(k) plans would also need to be added and communicated to all participants.
- The letter also mentions unique implementation obstacles faced by state and local governments and collectively bargained plans.
These organizations and companies further argue that if the U.S. Treasury Department or the IRS doesn’t provide relief, there might not be any catch-up contributions for 2024. But stay tuned. The IRS has previously delayed retirement plan rule changes and provided penalty relief, most recently with new RMD rules under SECURE 2.0 for inherited IRAs.
