A Tax Break Shake-Up: What You Need to Know
The Internal Revenue Service (IRS) has announced a significant change to a popular tax break for those approaching retirement, and it's a move that could impact your tax bill. But here's where it gets controversial: the new regulations might leave some high-income earners with fewer options for maximizing their retirement savings.
Last month, the IRS implemented a provision from the SECURE 2.0 Act, a 2022 law, which introduces a new rule for catch-up contributions to 401(k) plans. Starting with the 2026 tax year, high earners with an individual gross income of $145,000 or more in the previous year will be required to make these catch-up contributions to after-tax Roth accounts.
Under the current rules, which remain in effect until the 2025 tax year, workers aged 50 and above had the flexibility to choose between making their catch-up contributions to a before-tax traditional account or an after-tax Roth account. This allowed them to decide based on their tax strategy and the options provided by their retirement plan.
Making catch-up contributions on a before-tax basis offered an immediate tax benefit by reducing taxable income through deductions. However, the change means that high earners above the income threshold will lose this upfront tax break starting in 2026. Instead, they'll be directed towards after-tax Roth contributions.
Catch-up contributions are an additional savings opportunity on top of the standard 401(k) contributions. In 2025, eligible workers over 50 can contribute an extra $7,500 in catch-up contributions, on top of the standard limit of $23,500 for those under 50. Workers aged 60 to 63 have an even higher limit, with up to $11,250 in catch-up contributions allowed in 2025.
It's worth noting that workers whose employer-sponsored retirement plans don't offer Roth 401(k) options may find themselves unable to take advantage of these catch-up contributions until such an option becomes available. Fortunately, many employers are recognizing the demand and are adding Roth 401(k) options to their plans. For example, Fidelity now includes Roth 401(k) as an option in 95% of its managed plans, up from 73% just two years ago. Vanguard-managed 401(k) plans also show a high adoption rate, with 86% offering a Roth option.
For those contributing to traditional 401(k) accounts, the upfront tax break is a significant advantage. However, it's important to remember that future withdrawals from these accounts will be subject to income taxes. On the other hand, contributions to Roth accounts, while lacking the initial tax break, offer tax-free growth and withdrawals, making them an attractive option for long-term retirement planning.
So, here's the part most people miss: the upcoming change in tax regulations could significantly impact your retirement savings strategy. It's a complex issue, and we'd love to hear your thoughts. Do you think the new rules are fair? Will they affect your retirement planning? Let us know in the comments, and let's spark a discussion about this controversial topic!
