Clearing Up Confusion Over The New 401k Rule For Higher Earners (Important Update).
Now starting in 2026, some employees will eventually lose the tax deductibility of their "catch-up" 401k contributions to their retirement plan.
IMPORTANT .. On Friday August 25th 2023, the IRS announced that in order to facilitate an orderly transition to the new system, it was postponing the start date of the requirement described below from the beginning of 2024 to the beginning of 2026. As I reference in the article, concerns had been expressed about the difficulties for employers being able to change their plan and payroll systems in time. I have made some amendments to the content of the original article to reflect this development.
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There has been some confusion and misinformation on social media (shocker!) surrounding a new 401k rule coming into force at the beginning of 2024 2026 as part of the SECURE Act 2.0 passed at the end of 2022. Let’s clear it up.
Let’s start with .. who does this rule NOT affect? If any one of the following applies to you, then you don’t have to worry about this particular rule-change for 2024 and you can stop reading this article and go and do something else more useful.
You will be aged below 50 at the end of
20242026You expect to earn less than $145k in total wages during
20232025Even if you expect to earn more than $145k in wages this year, it will be split between more than one employer, with your
20242026 employer responsible for less than $145k of your total wages in20232025You do not plan to contribute more than $22,500 to your 401k in
20242026
This rule change has nothing to do with any employer contribution match. This has been the source of some of the confusion. There will be some changes regarding certain types of employer matching and I will send out an article about those shortly, but what we are talking about here is changes to what are called “catch-up contributions” to a 401k plan, exclusively available to those who are 50 years old or older at any point during the year.
Still with me? OK, so what do the new rules say?
In the year you hit 50, you start to become entitled to a higher annual 401k contribution limit than your under-50 co-workers who are restricted to a maximum contribution of $22,500 (2023). As an employee aged 50+, you are permitted to contribute an extra $7,500 per year, raising your total available limit to $30k (2023). This additional amount is referred to as the “catch-up contribution”
Previously, you could contribute this additional $7,500 to the same pre-tax plan as your $22,500 regular contribution, thereby getting the associated tax deduction for the total amount contributed. If a 50+ employee earned $150k in wages, he could put a total of $30k into his pre-tax 401k and be income-taxed as if he earned $120k ($150k minus $30k).
Under the new rules that take effect in 2024 2026, if that same employee earned $150k in wages only in 2023 2025 (thereby exceeding the $145k threshold for the prior year), then the $22,500 could still be contributed to the pre-tax plan in 2024, 2026 but any catch-up contribution amount above that must now be put into a Roth 401k account as post-tax money and therefore not eligible for the income tax deduction.
So instead of being taxed as if he earned $120k like previously, he will now be taxed as if he earned $127,500 ($150k minus $22,500), even though he made $30k in total 401k contributions.
So, a few comments:
This assumes that the employer has Roth 401k accounts available in their plan to put the $$ into. Many employers currently do not.
If there are no Roth accounts available in the plan for the higher earner 50+ employees to use for their catch-up contributions, then non-discrimination rules dictate that NO EMPLOYEES at all can make any catch-up contributions, regardless of their income. This would piss off a lot of older people in the plan. Stand by for a huge uplift in employers scrambling to get Roth 401k accounts in place with their providers by January
20242026. If your employer doesn’t have a Roth option, now might be a good time to ask them to get one.There is some debate over the definition of the word “wages” in calculating the $145k threshold, particularly when it comes to non-W2 people like company partners and sole proprietors
The $145k threshold is to be inflation-linked and will therefore likely increase every year
You could theoretically earn over $145k in
20232025 and still be eligible for putting your catch-up contribution into a pre-tax account in20242026 if you changed jobs during this year and the employer sponsoring your20242026 retirement plan paid you less than $145k in total wages in20232025
It’s not all bad news. Although you will no longer get a full tax deduction on any catch-up portion of your 401k contribution, this portion will, unlike the rest of your pre-tax 401k balance which gets added to your taxable income for the year that you withdraw it, now be completely tax-free upon withdrawal after age 59.5 and as long as the contributions have been in your retirement account for at least five years.
Anglia Advisors clients are welcome to reach out to me for more details.
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