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In a significant development in the retirement savings landscape, the Internal Revenue Service (IRS) recently announced a delay in the application of a new rule under the Secure Act 2.0. This rule, which impacts higher earners, was originally slated to take effect in 2024 but has been postponed until 2026.
What the Rule Entails
Individuals aged 50 and above are currently able to make a maximum catch-up contribution of $7,500 per year to their employer-sponsored retirement plan (401(k), 403(b), and 457). Under the SECURE Act 2.0, individuals earning $145,000 or more in the previous year are permitted to make catch-up contributions to their employer-sponsored plan, but the catch-up contribution must be made on an after-tax basis to a Roth version of the account. The result is the catch-up contribution won’t qualify for tax deductions as with typical contributions. The trade-off is the individual will be forced to pay taxes on the catch-up contribution in the current year but can withdraw those funds tax-free in retirement.
The Industry's Plea
The industry had been expressing concerns about the feasibility of implementing the new rule by 2024. Retirement plan sponsors who don’t currently offer a Roth option within their 401(k), 403(b), or 457 plan would have to move quickly to comply with the new rule, with many stating that the 2024 deadline is unrealistic. Over 200 entities, including Fortune 500 companies, firms, and public employers, requested Congress for a two-year delay to the rule's implementation, citing the need for new payroll systems and administrative work.
The plea worked, and on August 25th the IRS announced that the new requirement for Roth catch-up contributions for high earners will be postponed until 2026, providing much-needed relief for many plan sponsors and employers.
What This Means Going Forward
If you're age 50 or older, no matter your income level, you can continue to make catch-up contributions on a pre-tax basis through your employer-sponsored retirement plan. However, those catch-up contributions will eventually (in 2026), have to be made on a Roth basis if your income meets or exceeds the $145,000 threshold. Therefore, it's still a good idea to start planning now and consult a tax professional to determine the best way to maximize your retirement savings.
More Opportunities to Plan
This development underscores the importance of staying informed about changes in tax law and planning accordingly. While the delay provides higher earners more time to adhere to the new requirements, it's still important to adjust financial plans according to the eventual changes in the law.
The Tax Cuts and Jobs Act lowered tax rates for individuals, but those tax cuts are scheduled to sunset at the end of 2025 if Congress doesn’t intervene. For higher earners who are cheering the delay of the new Roth rule, they might want to consider making after-tax Roth contributions prior to 2026, to potentially take advantage of lower tax rates while they last. Investors should consult with their tax professional to determine the best option based on their financial circumstances.
Time will tell how these rules play out, and what changes we might face in the future, but the key is to stay informed and plan ahead. This way, regardless of legislative changes, you can continue to build wealth and effectively plan for your future.
Tad Jakes, CFP®, EA