IRS Delays Change to Retirement Savings Contributions, Allowing Higher Earners More Time for Pre-Tax Catch-Up Contributions
The IRS has announced a two-year delay for a change that would have affected retirement savers, particularly higher earners, who make catch-up contributions to their retirement plans. Currently, individuals aged 50 and older are allowed to make catch-up contributions, which means they can funnel extra money into their 401(k) and other retirement plans beyond the employee deferral limit. However, a change introduced under Secure 2.0 was set to eliminate the tax break for higher earners by only allowing these deposits in after-tax Roth accounts starting in 2024.
The IRS’s decision to delay the change means savers can continue to make pretax catch-up contributions through 2025, regardless of their income. This provides higher earners with more time to maximize their retirement savings. Currently, catch-up contributions allow savers aged 50 and older to contribute an additional $7,500 into their 401(k) plans and other retirement plans, beyond the $22,500 employee deferral limit for 2023.
The IRS stated that the two-year delay would help taxpayers transition smoothly to the new Roth catch-up requirement. The change under Secure 2.0 would have applied to employees making catch-up deposits to 401(k), 403(b), or 457(b) plans who earned more than $145,000 from a single company in the prior year. According to a recent Vanguard report, about 16% of eligible employees took advantage of catch-up contributions in 2022.
Retirement plan administrators are relieved by the delay, as it provides more time for preparation. Dan Galli, a certified financial planner and owner of Daniel J. Galli & Associates, commented that there was no way to implement the change without a couple of years of preparation.
The decision to delay the change was welcomed by many organizations, as expressed in a letter sent to Congress in July. Retirement plan sponsors appreciate the “critically important relief” the delay provides, according to Diann Howland, vice president of legislative affairs for the American Benefits Council.
While higher earners now have an extra two years to make pre-tax catch-up contributions, some may still consider after-tax deposits due to the impending income tax law changes. Galli suggests that the delay coincides well with the changing tax brackets expected in 2026, as several provisions from the Tax Cuts and Jobs Act, including lower individual tax rates, are set to expire after 2025 without intervention from Congress.
While pre-tax 401(k) contributions offer an upfront tax break, after-tax Roth deposits allow funds to grow and be withdrawn tax-free in retirement. With potential tax hikes on the horizon, some investors may find it advantageous to pay taxes now. Galli advises clients to leverage the lower tax brackets for as long as possible.
Overall, the delay in implementing the change to retirement savings contributions provides higher earners with additional time to make pre-tax catch-up contributions. This decision gives them more flexibility in managing their retirement savings while also considering possible tax implications and changes in the future.