by Casia Chappell, CFP®, CPWA®
Vice President
Wealth Planning
On December 29, 2022, Congress signed a piece of legislation called SECURE Act 2.0 of 2022. Compared to the SECURE Act 1.0 that was enacted in December of 2019, which contained 29 provisions and total government spending of $15 billion, the SECURE Act 2.0 contains 92 provisions and $1.7 trillion in spending. Both pieces of legislation were designed to promote retirement security, including attempts to lower barriers to entry for people looking to save, expand access to participation in employer retirement plans and allow for greater flexibility for Americans experiencing hardship.
Among the 92 provisions included in the SECURE Act 2.0, one stands out as a potentially significant change for employed individuals over the age of 50, as well as their employers, because it affects catch-up contributions starting in 2024. Under current law, employees participating in typical employer retirement plans, including 401(k), 401(a), 403(b) and 457(b) plans, can deduct up to $22,500 in 2023 from their earnings to contribute towards their future retirement. Employees over the age of 50 are eligible to make an additional contribution of $7,500, commonly referred to as a “catch-up” contribution, for a total of $30,000 in total employee contributions.
History of Catch-Up Contributions
Catch-up contributions were a new feature of retirement planning introduced in 2002 when employees over the age of 50 were allowed to contribute an extra $1,000 to their 401(k)s. At the time, the 401(k) contribution limit was $11,000, thus the added $1,000 represented just 8% of the total maximum. Over the years the catch-up portion of the total has increased in relative size and is now a more meaningful component of the total amount, representing 25% of the total maximum contribution in 2023.
Another evolution to the employer retirement plan landscape occurred in 2006 when plan providers were allowed to offer employees the option of making elective deferrals on a traditional pre-tax basis or on a Roth post-tax basis.
“Rothification” of Catch-Up Contributions
The focus of this article is a provision requiring plan participants over the age of 50, who earned over $145,000 in wages (as defined by Internal Revenue Code Section 3121(a)) from the same employer during the previous year to make their catch-up contributions as Roth and not pre-tax. The provision also specifies that unless the plan allows for Roth contributions then no employees can make catch-up contributions of any kind, regardless of their income.
As a result, employees over the age of 50 looking to maximize their contributions to one of these workplace retirement plans should ask their employer to ensure that there is a Roth option available so that catch-up contributions are allowed. If the retirement plan doesn’t currently allow for Roth contributions, the plan documents must be amended, which may take some time. Employers may also need additional time to update their record-keeping processes and procedures in order to track and communicate these nuances to participants.
There are a couple of notable exceptions to the provision. The first is that the requirement does not apply to select self-employed retirement plans including SARSEP or SIMPLE IRA. The second exception is the provision only applies to employees who earned $145,000 in wages from the employer sponsoring the plan during the previous year. A potential inadvertent loophole was created due to the wording of the bill that has been interpreted to mean that an employee who earned less than $145,000 from any single employer during the previous year would remain eligible to make a pre-tax catch-up contribution. Therefore, someone who switches employers during the year but does not exceed $145,000 from either one would still be able to make pre-tax catch-up contributions.
While the requirement for select catch-up contributions to be post-tax reduces the ability to defer taxes, the Roth IRA savings will likely prove advantageous for many savers.
Please reach out to your portfolio manager and tax advisor if you have questions about how the many changes put forth by the SECURE Act 2.0 may impact you specifically.
Ferguson Wellman, Octavia Group and West Bearing do not provide tax, legal, insurance or medical advice. This material has been prepared for general educational and informational purposes only and not as a substitute for qualified counsel. You should consult qualified professionals to understand how this information may, or may not, apply specifically to you.