Changes Coming to Retirement Catch-Up Contributions

The Securing a Strong Retirement Act (also known as SECURE 2.0) was signed into law at the end of 2022. It introduced some important changes when it comes to retirement saving—like bumping up the age for required minimum distributions (RMDs) and allowing for larger catch-up contributions. But the IRS recently announced that it’s delaying some key changes. The news will likely affect the way high-income earners save for retirement. Here’s what you need to know.

What's changing?

Catch-up contributions enable individuals who are 50 and older to contribute more to tax-advantaged retirement accounts than the standard contribution limit permits. In 2023*, these individuals have the opportunity to contribute an extra:

• $7,500 to 401(k) or 403(b) accounts.
• $1,000 across all traditional and Roth IRAs.

Traditional 401(k) and 403(b) contributions are excluded from your income, which reduces your taxable income today. Contributions to traditional IRAs are generally tax deductible. SECURE 2.0 made a key change. At a certain point, many folks who earn more than $145,000 will be able to make qualified retirement plan catch-up contributions only to after-tax Roth accounts. That will effectively cut them off from extra pretax contributions. Originally, this was supposed to begin in 2024. According to the IRS, this change now won’t take effect until 2026.

Who will it affect?

Once the change begins, it will affect employees who earned more than $145,000 from a single employer during the prior year. These folks will no longer be able to make pretax catch-up contributions to qualified retirement plans such as 401(k)s and 403(b)s. This change does not apply to IRA contributions.

Why it matters

Unlike traditional IRAs and 401(k)s, Roth contributions are not excluded from income. While Roth accounts allow for tax-free distributions in retirement, contributions don’t lower your taxable income during your working years. The delayed change gives high-income earners an extra two years to make catch-up contributions to pretax retirement accounts.

SECURE 2.0 is bringing another important change to retirement planning. Starting in 2025, folks who turn ages 60 to 63 in a given year can make larger catch-up contributions in that year to a SIMPLE IRA, SEP IRA, or qualified retirement plan such as a 401(k) or 403(b)—up to $10,000 or 150 percent of the plan’s standard catch-up limit for a given year (whichever is greater). Beginning in 2026, that $10,000 cap will get an annual inflation adjustment.

Looking at the bigger picture of retirement income

Understanding these changes can help you plan accordingly, especially where catch-up contributions are concerned. High earners now have two extra years to maximize tax savings during their working years. But the upcoming changes underscore just how important it is to diversify your retirement income.

Remember that 401(k) and traditional IRA distributions are taxable income. If the bulk of your nest egg is in these types of accounts, you could be looking at a significant tax burden in retirement. Withdrawing too much in a given year could also push you into a higher tax bracket—and you’ll need to take those RMDs at some point.

Having a mix of different income sources can help you rely less on taxable withdrawals. Consider the following sources of retirement income:

• Social Security: While you can technically begin taking Social Security at 62, holding out has its perks. Your monthly benefit increases for every year you wait, up until age 70. When it comes to taxes, you’ll never be taxed on more than 85 percent of your Social Security benefit.
• Annuities: An annuity can provide guaranteed retirement income, often for the rest of your life. They’re available for purchase through insurance companies. In exchange, you’ll receive steady monthly payments in retirement. The right annuity can help reduce the chances of outliving your nest egg.
• Life insurance: Permanent life insurance can play a central role in retirement planning. Over time, this type of policy accumulates cash value—and that can be a nice add-on to your retirement income. It can also come in handy during market downturns. Life insurance may ultimately ease the pressure on taxable accounts by providing cash as needed.
• Cash reserves: Emergency funds are always necessary, even in retirement. Having two years’ worth of liquid assets on hand in retirement can help you weather unexpected financial storms, big and small—from a surprise home repair to an unplanned medical expense.
• Other investments: Money in brokerage accounts, health savings accounts, or Roth accounts can help you rely less on taxable distributions in retirement. Just as you diversify your investment portfolio, you can also create a healthy mix of retirement income sources.

An experienced financial advisor can help you build a retirement income plan based on your needs. That includes planning ahead for catch-up contribution changes.

*The 2024 figures will likely be released in October 2023.

Utilizing the accumulated value of life insurance policies through policy loans, surrenders or cash withdrawals will reduce the death benefit and may necessitate greater outlay than anticipated and/or result in an unexpected taxable event.