High Earners 50 and Up Get Two-Year Reprieve From IRS on 401(k) Rule

Protax explains that on August 25, 2023 the IRS postponed a mandate that was due to kick in starting in 2023 to 2026 for higher income tax earners making more than $145,000 that would have required their catch up contributions on 401(k)/ 403(b) and Thrift plans to be placed in after tax ROTH style IRA accounts versus pre tax accounts.

Higher earners age 50 and up will get two more years to use pretax dollars for all of their retirement savings in 401(k)s and similar plans, after the Internal Revenue Service delayed a new requirement. 

The IRS late Friday postponed until 2026 a law that was scheduled to take effect next year, and the agency gave more flexibility to older workers trying to decide how to plan their retirement savings. 

The change enacted by Congress last year will force high earners to put so-called catch-up contributions into Roth-style accounts funded with posttax dollars. The law applies to workers who made more than $145,000 in wages during the prior year and who contribute more than the general maximum for 401(k)s, which is $22,500 this year. 

In a notice, however, the IRS said it was trying to create an orderly transition to the new system and postponed the requirement until 2026. Employer groups had been warning officials about the difficulty of changing their systems in time. 

Under current law, contributions to 401(k) and similar plans are capped at $22,500 this year. But savers ages 50 and older can make catch-up contributions beyond that into their 401(k) accounts each year, with eligible workers allowed to put an extra $7,500 into their accounts, for a total of $30,000, this year. Those catch-up payments can be made with pretax or posttax dollars. 

As part of a broader retirement law last year, Congress required that high earners make those catch-up contributions in post tax dollars. The change was designed in part to raise money within the 10-year budgetary window that Congress uses. It thus helped to raise revenue for other changes such as a delay in the starting age for required minimum distributions from tax-deferred accounts.

In traditional retirement accounts, savers put pretax dollars in and then pay regular income-tax rates when they withdraw money in retirement. Roth-style accounts are the reverse—taxpayers contribute posttax dollars but future appreciation and withdrawals can be tax-free. 

Generally, taxpayers who expect higher tax rates in retirement than while working would prefer Roth-style accounts, while those who expect their tax rates to decline prefer traditional accounts. 

Requiring savers who are in peak earning years to contribute after-tax dollars to Roth plans seems to put these savers at a disadvantage. But Roth savings, even in peak earning years, could also bring needed flexibility for savers who routinely save the maximum allowed in traditional accounts. 

The tax agency also resolved a potential glitch in legislation that had been worrying some investors and retirement-industry companies. Some had read last year’s legislation as inadvertently banning all catch-up contributions. The IRS said Friday that that isn’t the case. Top tax writers in Congress had said that they didn’t intend to ban catch-up contributions and were considering legislation to clarify last year’s law. 

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