IRS Shifts Gear on New Roth 401(k) Rule Implementation – What You Need to Know

Higher-income earners affected by updated catch-up contribution regulations for Roth 401(k) accounts can now breathe a sigh of relief thanks to the new measure introduced by the IRS. Here is what you should be aware of regarding this development.

There has been recent attention on the proposed changes to regulations regarding catch-up contributions in 401(k) retirement plans. Originally scheduled to take effect in 2024, these revisions require individuals with higher incomes to make catch-up contributions on a Roth basis. This approach involves contributing after-tax funds to your retirement savings during peak earning years, resulting in tax payments during those years.

Under the provisions of SECURE 2.0, if you are aged 50 or above and earned a minimum of $145,000 in the preceding year, you are allowed to make catch-up contributions to your employer-sponsored 401(k) account. However, these additional contributions must be made using after-tax funds on a Roth basis.

While you won’t benefit from tax deductions on these catch-up contributions as you would with standard 401(k) contributions, the advantage lies in withdrawing these funds tax-free during your retirement.

It’s important to note that the SECURE 2.0 Roth catch-up contribution rule does not apply to taxpayers earning $144,999 or less in a given tax year.

Complications with Roth catch-up contributions 

Although the revised regulation appears logical, clearer guidance was needed to implement Roth catch-up contributions for 2024. Drafters of the Roth catch-up provisions within SECURE 2.0 failed to include specific language. Consequently, according to the current wording of SECURE 2.0, no participants can make catch-up contributions, whether on a pre-tax or Roth basis.

Numerous employers, plan sponsors, and organizations expressed reservations that the upcoming 401(k) contribution rule changes couldn’t be effectively enacted by the following year. Over 200 entities, including Fortune 500 companies, firms, public employers, and notable names like the American Retirement Association, Chipotle Mexican Grill, Fidelity Investments, Charles Schwab, Microsoft Corporation, and Delta Airlines, collectively petitioned Congress for a two-year postponement of the Roth catch-up rule until 2026.

A primary concern revolves around the need for new payroll systems and administrative procedures, which many employers worried would not be ready to accommodate participants making Roth catch-up contributions in the upcoming year.

IRS extends timeline for Roth catch-up preparations 

In a recent announcement on a Friday evening, the IRS introduced a reprieve for high-income earners affected by the rule. This news is also greeted with relief by numerous plan sponsors and employers. The IRS declared that individuals aged 50 or above, falling under the category of high earners, will not be required to implement Roth catch-up contributions until 2026. This constitutes a two-year postponement of the new regulation.

The IRS further clarified that participants aged 50 or older can continue to make pre-tax catch-up contributions in 2024, regardless of their income level.

Implications of the IRS decision: 

If you are 50 or older, you can make catch-up contributions on a pre-tax basis through your retirement plan, regardless of your income and whether it’s facilitated by your employer or not. Nonetheless, the IRS emphasizes that these catch-up contributions will eventually need to be executed on a Roth basis starting in 2026 if your income surpasses or meets the $145,000 threshold.

In light of these developments, it remains prudent to initiate your planning process now and seek advice from a trustworthy tax professional to determine the optimal approach for maximizing your retirement savings.