The SECURE Act 2.0 signed at the end of 2022 has a goal of strengthening the retirement system while encouraging Americans to better prepare for retirement. With the passage of the new law came several retirement plan changes, some that have already taken effect and some that will be rolling out over subsequent years. There are three provisions that impact retirement catch-up contributions, with the first change starting in 2024. The new regulations will impact how much someone can save based on their age, as well as the income tax treatment of those savings.
One of the changes is straightforward (for the most part). For Traditional and Roth IRAs, a catch-up contribution of $1,000 exists for those age 50 and older. Historically, this catch-up amount has not automatically been increased for inflation. In fact, the $1,000 amount has been the same since 2006, even though the regular contribution limit has increased by 75% over that period. The new law applies a cost-of-living adjustment to the IRA catch-up amount. The law began with the 2024 tax year but did not actually create an adjustment; the catch-up is still $1,000 for 2024. The inflation adjustment will be made in $100 increments and therefore the actual increase may not be noticeable for another few years even though the law is effective with 2024.
The next two changes have some conditions that could make them more challenging to implement. Fortunately, they are not effective until 2025 and 2026, allowing more time to adjust and set expectations.
2025: Persons aged 60, 61, 62 and 63
Starting in 2025, persons aged 60, 61, 62, and 63 will have a higher catch-up contribution amount for 401(k) and similar plans. When the law was enacted, the higher amount was defined as the greater of $10,000 or an amount equal to 150% of the regular catch-up amount in 2024. The regular catch-up amount for those aged 50 and older is $7,500 for 2024; thus, one would expect the 60 through 63 catch-up in 2025 to be $11,250. This could create a strange “donut hole” for some plan participants in the coming years. For example, a person aged 62 in 2024 could contribute a total of $30,500 as an elective deferral ($23,000 plus $7,500 catch-up). Then in 2025, at age 63, the total contribution would rise to $34,250 including the higher catch-up. Next year at age 64, the higher catch-up no longer applies, and the total contribution would go back down to $30,500. Now, those figures will change slightly with annual cost of living adjustments, but conceptually people should be aware that their limits may go up and then go back down again if they fall into this age range.
2026: High Wage Earners if Age 50 or Older
Effective 2026, high wage earners will be required to use the Roth option for any 401(k) catch-up contributions. This applies to those aged 50 and older. Mandatory Roth usage for catch-up contributions will apply if wages from the plan sponsor in the prior year are greater than $145,000. There are still some practical issues outstanding with this rule, such as how to handle someone who changes jobs during the year and self-employed individuals – factors contributing to the delayed implementation. As the Treasury continues to release clarifications to SECURE 2.0 provisions, expect more specifics to come out on exactly how this should work. For now, persons with wages above the $145,000 limit should consider that their catch-up plan contributions should still be allowable but may not get an income tax deduction if treated as Roth. Even though the current year deduction may be lost, the upside is that the Roth bucket should be income tax-free when withdrawn and not subject to required minimum distributions during your lifetime.
Impacts
Even though what we’re discussing here won’t impact savings, paystubs or taxes for another year, these factors are already included in our long-term planning projections. When we use our planning tools to discuss your savings rate or overall cash flow, it’s important that these changes have been incorporated for a better understanding of your plan and to avoid surprises heading into 2025 and 2026. Your Heritage team will keep working to help you make informed decisions in the years to come.
Additional Resources: Important numbers you need to know for 2024.
https://www.congress.gov/117/bills/hr2617/BILLS-117hr2617enr.pdf
