Changes coming to Roth retirement catch-up contributions at work

The SECURE 2.0 Act⁽¹⁾ was enacted last year with many changes for all retirement accounts, including popular workplace plans like the 401(k). While the law’s primary objective is encouraging more Americans to invest for retirement, some changes have confused retirement plan participants and their employers.

Some SECURE 2.0 requirements began in 2023, but others will start in 2024 or later. One of the rules regarding catch-up contributions for workplace retirement plans was so hotly contested by industry groups, employers, plan sponsors and financial organizations that the IRS delayed its implementation until 2026. Here’s what you need to know about the future of catch-up contributions.

What are retirement account catch-up contributions?

For 2023, participants in a 401(k), 403(b) or governmental 457(b) plan can contribute up to $22,500. However, if you’re over 50, and your plan allows it, you can defer more of your paycheck, a catch-up. You can contribute an extra $7,500 for a total of $30,000. That allows older workers to boost their retirement account if they get a late start saving.

Before SECURE 2.0, you could make pre-tax catch-up contributions to a traditional workplace plan or post-tax to a Roth option. However, the new law puts an end to that for certain workers. It says that employees with wages that exceeded $145,000 in the prior calendar year can only make catch-up contributions on an after-tax, Roth basis.

What’s the difference between traditional and Roth catch-up contributions?

While traditional and Roth workplace retirement plans are both vehicles for savings, they have different tax treatment, including the following:

• Contributions: Traditional contributions are made with pre-tax dollars and reduce your annual taxable income. Roth contributions are made with after-tax dollars, requiring you to pay taxes on them with no upfront tax benefit.
• Withdrawals: Traditional withdrawals get taxed as ordinary income. Roth withdrawals are entirely tax-free in retirement.
• Required minimum distributions (RMDs): Traditional retirement accounts require you to take minimum distributions starting at 72 (73 if you reach 72 after December 31, 2022). Roth accounts have no RMDs.

What are the pros and cons of Roth catch-up contributions?

When high earners over 50 make after-tax, Roth catch-up contributions, they won’t get a tax deduction and could be surprised by a higher-than-expected tax bill. But a significant upside is not paying tax on their account growth and withdrawing them entirely tax-free in retirement.

Another benefit of Roth contributions is that you can withdraw them at any age without taxes or penalties. However, withdrawals of earnings before age 59.5 and before you own the account for five years would be subject to taxes plus an additional 10% early withdrawal penalty.

In general, traditional retirement contributions are beneficial if you believe tax rates will decline or you’ll be in a lower tax bracket in retirement than today. You get a tax break now but must pay taxes when you take withdrawals and RMDs.

Roth contributions are beneficial if you believe tax rates will increase or you’ll be in a high tax bracket in retirement. You pay taxes now at a comparatively lower rate and enjoy tax-free withdrawals in retirement.

Why is the Roth catch-up requirement delayed?

The ‘Roth-ification’ of catch-ups was delayed from 2024 to 2026 for several reasons. One is that some employers with retirement plans don’t currently offer a Roth option. Another is that employers now have the administrative burden of verifying an employee’s prior year wages. If a worker is new, the payroll department would need to seek that information from their ex-employer if not provided by the IRS.

Two additional years should give employers enough time to add a Roth option and give benefits departments and payroll providers more time to update their recordkeeping systems, do administrative work and implement this significant change.

What happens with catch-up contributions until 2026?

If you’re over 50, no matter your income, you can make pre-tax catch-up contributions to your retirement plan at work for 2023, 2024 and 2025. So, take advantage of the opportunity to contribute more and grow your retirement nest egg.