Bill C. from St. Louis, MO asks: Good morning, Mitch, I’m a couple of years out from retirement and have been relying on the so-called “catch-up” contributions to juice my nest egg in my final working years. But I read somewhere recently that for high-income earners, there may be some changes coming down the pipeline for catch-up contributions. Is this true, and if so, what are the changes? Any other options I have? Thank you.
Mitch’s Response:
Thanks for sending your question, Bill. The SECURE 2.0 Act has many retirement-related changes and adjustments in it, so there are many to sort through. “Catch-up” contributions are one of them.1
As you’re likely aware, the rules allow for workers aged 50 and older to make an additional $7,500 contribution to their 401(k)s, above the $22,500 max contribution currently allowed for 2023. That means you can sock away a total of $30,000 into your 401(k) each year.
But your question hits on a key provision. That is, if you earned more than $145,000 the previous year, then the additional $7,500 contribution is no longer tax deductible, and the money cannot go into your 401(k). The catch-up contribution flows into a Roth IRA instead. High-income earners get dinged on taxes, since a $7,500 catch-up contribution would have amounted to a $2,625 tax deduction for someone in a 35% tax bracket.
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While this change does not seem ideal at first glance, there are a few positives to consider. The first is that your catch-up contributions are now after-tax, and in a Roth, they will grow and can be withdrawn tax-free. If you do not yet have savings in a Roth, it’s a good retirement “bucket” to start filling. If all of your retirement income would otherwise come from your 401(k), it might bump you into a higher tax bracket which could also mean higher Medicare premiums. If you’re thinking about estate plans, Roth IRAs are also advantageous for heirs, since they will receive tax-free income.
There are certainly some preparations and adjustments you’ll likely need to make in your retirement and estate plan. But from the looks of it, these new rules may not come into effect this year. Many companies and 401(k) record keepers are lobbying Congress for more time, since making these changes requires several system updates that many companies and providers do not think they have time to make before the end of the year. The rule change is in somewhat of a “wait-and-see” mode now.
The bottom line is that the tax treatment of your $7,500 catch-up contribution is likely to change, but I do not think it should alter your plan to go ahead and save that money into a retirement account. It will just be in a Roth moving forward.
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Disclosure
1 Wall Street Journal. July 16, 2023. https://www.wsj.com/articles/retirement-tax-breaks-401k-contributions-2868ffdc?mod=markets_major_pos6
2 ZIM may amend or rescind the “8 Steps Towards a Stress-Free Retirement” guide for any reason and at ZIM’s discretion.
3 ZIM may amend or rescind the “8 Steps Towards a Stress-Free Retirement” guide for any reason and at ZIM’s discretion.
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