Starting this year, higher-earning Americans age 50 and over face a shift in how they can make extra contributions to their workplace retirement plans, with new rules requiring some to pay taxes on those savings earlier than before.
New Contribution Rules
Under the new rule, brought in under the SECURE 2.0 Act of 2022, workers age 50 or older who earn $150,000 or more in FICA-taxable income will no longer be able to make catch-up contributions to a traditional pretax 401(k). Instead, those additional contributions must go into a Roth 401(k), meaning they are made with income that has already been taxed.
Catch-up contributions allow older workers to boost their retirement savings beyond the standard annual limit. Colleen Carcone, the director of wealth planning strategies at the financial retirement services firm TIAA, explained to Newsweek: “Taxpayers that participate in an employer-sponsored retirement plan can contribute up to $24,500 to their plan. All taxpayers over age 50 can contribute an additional $8,000 ‘catch-up’ contribution each year, and for taxpayers age 60 to 63, that catch-up contribution amount is $11,250.”
Previously, savers could choose whether those extra contributions were made on a pretax or posttax basis. Now, that flexibility has been removed for higher earners.
Carcone said the updated rule, which took effect on January 1, means those who “have more than $150,000 in W-2 wages from the employer sponsoring the plan (for the prior year) will only be permitted to make catch-up contributions in after-tax dollars.”
Importantly, the rule applies only to catch-up contributions, not standard contributions, and is determined using the prior year’s W-2 earnings. Workers below the $150,000 threshold are not affected and can continue choosing between traditional and Roth contributions, depending on what their employer offers.
Impact on Income
For those who fall under the new rule, the shift could affect their paychecks.
Because traditional 401(k) contributions reduce taxable income up front, they lower the amount of income used to calculate tax withholding. Roth contributions do not offer that same immediate tax break.
Carcone said: “Federal and state income tax withholding is calculated after all pretax deductions are subtracted from an employee’s wages. If an employee makes after-tax contributions to an employer plan, the tax base on which withholding is calculated and the worker’s income will be higher.”
As a result, workers making Roth catch-up contributions may see a reduction in their take-home pay compared to previous years when those contributions could be made pretax.
Paying Taxes Up Front
While the rule may feel like a tax hike, Carcone said it primarily changes when taxes are paid, rather than how much is ultimately owed.
“This shifts the timing in which taxes are paid by the employee,” Carcone said. “Having a smaller paycheck may cause some pain today, but it is not all bad news.”
Traditional retirement contributions are taxed when funds are withdrawn in retirement, including any investment growth. However, Roth contributions are taxed up front—but qualified withdrawals, including earnings, are tax-free.
“While there may be an increase in current income tax liability, Roth retirement plans offer individuals many tax advantages once they retire and begin taking distributions,” Carcone said.
Among those advantages, Roth accounts are not subject to required minimum distributions, giving retirees more flexibility over when and how they draw down their savings. She said that because withdrawals are tax-free, “the growth on those accounts effectively will escape taxation.”
