Next year, new regulations will impact high-income individuals making “catch-up” contributions to 401(k) plans or similar tax-deferred retirement accounts. These rules, established by the Safe 2.0 Retirement Act, will effectively remove the immediate tax benefits traditionally associated with such catch-up contributions alongside standard 401(k) contributions, as well as those from 403(b), 457(b), simplified employee pension plans (SEP), and simple IRAs. Here’s a look at the changes and their potential effects.
For those over 50 who max out their 401(k) contributions (which is capped at $23,500 this year), there’s the option to contribute an additional “catch-up” amount. This year, that limit is set at $7,500, or up to $11,250 for participants aged 60 to 63, depending on employer allowances. These limits are adjusted annually based on inflation.
Currently, you can choose to defer taxes on the full amount you contribute to your 401(k). This helps reduce your taxable income and allows your contributions to grow without immediate tax implications until you start withdrawing during retirement. However, starting next year, if you’re over 50 and earn more than $145,000 in FICA wages, these catch-up contributions will be taxed as regular income in the year they are made. In essence, they’ll be treated similarly to Roth 401(k) contributions.
After you invest this after-tax money, it can grow tax-free, so long as certain conditions are met—primarily that you keep the money in the account for at least five years and you’re at least 59½ when you start withdrawing. Interestingly, around 93% of workplace retirement plans offer the option to create a Roth 401(k), according to a 2024 survey by the American Council on Planning Sponsors. But if your plan doesn’t provide this option, you won’t be able to make catch-up contributions, even if you’re over 50.
Impact of the Rule Changes
It’s important to note that these new regulations won’t affect those eligible for catch-up contributions who earn below $145,000, a figure which might increase due to inflation. That said, high-income earners will face both potential advantages and drawbacks.
On one hand, you’ll have to pay taxes on some of your retirement savings during what may be peak earning years, which could lead to a higher tax rate on those contributions than if you were to retire. This uncertainty—about where future tax rates will go—makes planning a bit tricky. As Brigen Winters from Groom Law Group points out, opting for catch-up contributions means you’re essentially footing the bill for more taxes to the federal government.
In other words, “Your take-home pay could take a hit,” according to Kapek.
However, there are some upsides to the new rules. For instance, the funds you invest in Roth 401(k) accounts can grow tax-free, and you won’t be required to make minimum withdrawals upon turning 73, unlike traditional tax-deferred contributions. Additionally, having tax-free funds in retirement can offer more flexibility when managing your overall financial strategy, especially regarding income sources like Social Security benefits.
