The Retirement Tax Break That's Going Away

Catch-up Contributions will have to be made after taxes for taxpayers earning income above $145,000

Starting in 2024 as part of the Secure 2.0 legislation, taxpayers earning over $145,000 per year are poised to lose a popular tax break. High-paid participants will no longer be permitted to make pre-tax catch-up contributions to their retirement accounts. For clarity's sake, this change applies to qualified retirement plans such as a 401(k), 403(b), and 457(b) plans, but not to Individual Retirement Accounts (IRAs) which individuals over age 50 can contribute an extra $1000 per year. Next year, catch-up contributions can only be made "after-tax" into an individual's 401(k) account as their plan sponsor is required to offer a Roth feature, Roth 401(k)s grew in popularity the past few years as savers became more aware of their benefits. From here on, we'll delve into what this means for retirement savers and what you should do in light of this change.

Benefits of After-tax Savings

Having extolled the benefits of the Roth IRA, I would generally recommend that savers should continue to make catch-up contributions once their sponsor offers a Roth feature to their 401(k) plan. What's particularly interesting to me is the opportunity for individuals phased out of deductible IRAs, to make backdoor Roth IRA contributions in addition to their Roth 401(k) contributions, thereby accelerating tax-free growth in their retirement accounts. This is a potential boon for retirees who take advantage of this tax-free growth as they won't be required to take distributions from these accounts when they reach age 73. Additionally, they won't have to pay taxes on the monies they withdraw regardless of how much their accounts have grown. Lastly, their heirs would benefit as Roth accounts are tax-free to beneficiaries as well.

The prevailing wisdom dictates that retirees should reside in lower tax brackets since they no longer earn a steady income However, high-earners typically find themselves burdened by higher rates as the IRS requires them to take distributions from their substantial retirement accounts at age 73. Making catch-up contributions to your Roth 401(k) will provide a nice nest egg to draw from in your retirement without blowing up your tax bill.

Potential delays in implementation

With this new provision in Secure 2.0 is slated to begin January 1st, companies and plan sponsors will be required to offer a Roth feature to High-Paid participants. however, they've requested a delay in implementing this feature. The root cause for this delay is due to a glitch in the language used in the legislation. The law as stated prohibits all workers from making catch-up contributions next year. This was not intentional according to representatives and a fix is promised to correct the legislation. It remains to be seen when this will happen but I would anticipate this new provision to take effect next year.

Final Thoughts

Those who regularly make catch-up contributions to their retirement plan might question the value in doing so with this new provision. However, I would recommend to continue making such contributions if your budget allows for it. While you might pay up front, the tax-free growth makes the initial tax-hit worthwhile. It's important to talk to your tax practitioner and/or financial advisor when making such decisions as this strategy might not be ideal for everyone.

IMPORTANT DISCLOSURES AVL CPA Firm, LLC. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual's personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.