The IRS recently announced that it will extend the new provision stemming from SECURE Act 2.0 that requires employees with annual income exceeding $145,000 to divert their 401(k) catch-up contributions into a Roth 401(k) account.
This “administrative transition period” extension by two years to 2026 comes on the heels of widespread appeals to Congress to postpone the enforcement of this regulation as employers and plan administrators scrambled to amend plans by the original December 31, 2023, compliance deadline.
IRS Notice 2023-62 issued Friday states that “the administrative transition period will help taxpayers transition smoothly to the new Roth catch-up requirement and is designed to facilitate an orderly transition for compliance with that requirement.”
The IRS notice also provides clarification that plan participants who are age 50 and over can continue to make catch-up contributions after 2023 to either their 401(k) or Roth 401(k), regardless of income, until the new requirements kick in. Starting in 2026, those over age 50 with income above $145,000 can only make catch-up 401(k) contributions on an after-tax basis to a Roth 401(k).
How to Plan for the New Requirements
While the extension is welcomed, the new provision is still set to take effect in 2026. This means that high-income taxpayers have an opportunity to craft tax and estate planning strategies to effectively plan for the upcoming changes.
Employees impacted by this provision—those making in excess of $145,000 annually—can elect to max out their 401(k) catch-up contributions over the next few years to gain an exclusion from income, rather than being forced to forfeit the widely-used tax deduction that will be subject to mandatory Roth tax treatment in 2026.
Under current law, employees over the age of 50 can contribute a total of $30,000 into their 401(k) in 2023—the standard contribution limit of $22,500 plus an extra $7,500 catch-up contribution. The contribution limits for both a traditional 401(k) and a Roth 401(k) are the same in 2023; however, the total of your contributions to both accounts cannot exceed the contribution limit.
High income earners often favor traditional 401(k) plans because they allow upfront deductions on contributions, which means money is only taxed when it’s taken out, usually when income is lower in retirement.
While receiving an immediate deduction in the year contributions are made feels rewarding, paying taxes on withdrawals later in life can sometimes lead to challenges that many don’t consider, such as moving to a high-tax state or bumping into a higher tax bracket.
Let’s dive into the potential advantages of the new tax law—investing in tax-free growth and withdrawals in retirement.
Benefits of the New Tax Law
Now that the IRS has extended the compliance deadline to 2026, taxpayers with annual income over $145,000 now have more time to consider the benefits of investing catch-up contributions into their employer-sponsored Roth 401(k) plan.
While the traditional vs. Roth plans decision-making process remains the same—contribute to a Roth if your tax rate is lower than what you’d expect when you withdraw—some employees may fare better in the long-term, having their contributions build up tax free for life and for 10 years beyond to beneficiaries.
Further, there are a few reasons why Roth 401(k)s can offer more flexibility when accompanying uncertainties later in life:
- No required minimum distributions (RMDs) starting in 2024. Traditional 401(k)s require you to start taking withdrawals from your account at age 73, regardless of your financial situation. In 2024, Roth 401(k)s will not have RMDs, so you can leave your money in the account and let it continue to grow tax-free. This can be helpful if you need to delay retirement or if you experience a financial setback later in life.
- Early withdrawals without penalty. Roth 401(k) withdrawals are generally free from taxes and penalties if you’re 59½ or older and as long as your first contribution to your account was at least five years earlier. This can be helpful if you need access to money for an emergency or if you would like to use it to pay for a major expense, such as a vacation home or child’s education.
- Inherited by heirs income tax-free. When you pass away, your Roth 401(k) can be passed on to your heirs income tax-free. This can help your heirs avoid a large tax bill on your retirement savings. In addition, non-spouse heirs of traditional and Roth accounts are now required to clear out accounts within 10 years; however, Roth heirs can wait until the end of the timeframe, while heirs of traditional accounts must take taxable withdrawals each year.
If you are an employer with a 401(k) plan, be sure to contact your plan administrator for compliance with the new requirements.
Among the number of abovementioned advantages of this tax law change, high income earners can also benefit from the tax diversification to develop a tax-savvy withdrawal strategy in retirement.
Upcoming changes to retirement contributions underscore the importance of strategic tax and estate planning to properly navigate your financial future. Contact your advisor at R&A to project what these changes may mean for your situation.
About this Author
Laura specializes in income tax return preparation, compliance, and research for individuals and businesses. She also is experienced in preparing compiled and reviewed financial statements, individual and S-Corporation taxation, multi-state taxation, and income tax credits including the R&D credit.