The IRS says higher earners can wait to put their 401(k) into a Roth. Should you?

The Secure 2.0 bill enacted at the end of 2022 was such a huge bag of good that there are bound to be some snags. The IRS announced in a statement that one of the most important of these challenges — the requirement that high earners’ contributions go into Roth accounts — is getting a two-year delay, until 2026, to sort out the details. New notice.

The agency also noted that the line in the text of the bill that appeared to eliminate catch-up contributions for everyone after 2024 was an error and would not be considered.

For people 50 or older who earn more than $145,000, this allows them some extra time before they have to make any changes. This mostly affects employers, who now have more time to add Roth 401(k) benefits to their plans, if they haven’t already offered them.

But a two-year delay doesn’t mean retirement savers have to wait if they don’t want to. If your employer’s retirement plan offers a Roth 401(k) option, you can easily channel your catch-up contributions this way now, and it may benefit you in the long run.

The problem with compensatory contributions is that not many people make them. Even the basic 401(k) annual contribution limits have always been somewhat ambitious. Vanguard’s latest study says that only 15% of workers with a 401(k) contribute the maximum amount, which is $22,500 in 2023. This year’s catch-up contribution allows people 50 and older to make an additional $7,500. For a total of $30,000, but typically only 16% of those eligible to do so contribute any catch-up amount.

The Secure 2.0 change will require those earning more than $145,000 to put catch-up contributions into a Roth 401(k). For the most part, the people who earn this amount are the ones who make compensation contributions in the first place. The Vanguard study found that of those who contribute any additional amount, 58% have earned more than $150,000.

Roth benefits

With a Roth 401(k), your contribution is taxed as regular income for the current year, and then becomes tax-deductible for retirement. In a traditional 401(k), it’s the other way around—the money goes into the account before taxes and grows tax-deferred, and then gets taxed when you take it out in retirement.

There are all kinds of debates about the best tax model, and the answer depends on a person’s financial situation. But in general, for those who are 50 or older and earn more than $145,000, a Roth option can be a good strategy. “This way you immediately get some tax diversification,” says Maria Bruno, head of US wealth planning research at Vanguard.

That’s because the tax deferral of traditional 401(k) plans has a time limit: The IRS requires people to start withdrawing money from those accounts when they reach a certain age. He is currently 73 years old and will be 75 in a decade. It could be pushed even further in the future.

For higher earners, those required minimum distributions, known as RMDs, loom large. At some point, these hardworking savers will have to turn their attention to emptying those accounts into Roths, which have no distribution requirements — and are also more convenient for heirs.

If you’re in the 24% tax bracket, putting that extra $7,500 into your Roth 401(k) will result in a $70 increase in taxes per paycheck. If you defer these taxes until you’re 75, that contribution could grow to $25,000, and you’ll have to pay tax on it at whatever rate applies to you after that.

The bottom line is that you can’t avoid taxes on retirement savings forever, and at some point, the government will tell you what to do.

In fact, many higher earners are constantly looking for more Roth options. Over the course of their careers, they save money in traditional 401(k) accounts or other tax-deferred savings accounts. When they reach retirement age, they look for ways to get it out of those accounts, like huge Roths and Roths transfers. Instead, they can just contribute directly to a Roth 401(k) plan, which is offered by most employers.

“People are not used to it, but then they have problems at retirement age,” says Lawrence Spring, a certified financial planner and founder of the firm. Mitlin Finance In Haupuge, New York “They have so much money in tax-deferred money that they put themselves in a higher tax bracket when they get it.”

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