After announcing that it would place new requirements on catch-up contributions in 2024, the IRS has decided to delay the new rules until 2026. The new rules, provided by Secure Act 2.0, specifically affect savers 50 and older who reported income of $145,000 or more in the previous year. If these savers want to make higher, catch-up contributions to retirement accounts under the new rules, they will have to be made to Roth 401(k) accounts.
The late August announcement comes after concerns were raised about the new Secure Act 2.0 rules. Specifically, the new laws lacked specific language that made the requirements unclear. Because the Roth 401(k) accounts would largely need to be provided by employers, there were also concerns that employers would not have time to comply with the new regulations by the original January 2024 start date.
In an effort to help more Americans prepare for retirement, the tax code currently allows savers over the age of 50 to make additional “catch-up” contributions to tax-deferred retirement accounts like 401(k)s and Traditional IRAs. This rule has been beneficial to high-earners nearing retirement age who want to max out their contributions and has reduced their income taxes.
However, the Secure Act 2.0 was slated to make a critical change to the catch-up contribution rule starting January 2024. Starting then, savers 50 and older who earn more than $145,000 a year would only be able to make post-tax catch-up contributions to a Roth 401(k).
This rule — now scheduled for 2026 — essentially ends a beneficial tax break for high-earners. Instead of shielding a part of their income from taxes by making aggressive catch-up contributions to their 401(k), they’ll have to pay taxes on that income before saving it in a Roth 401(k). Many of these savers are in their peak earning years as well, meaning they’re in the highest tax bracket of their careers.
Despite the eliminated tax break, there are financial experts who, perhaps surprisingly, believe the new Roth 401(k) rule will benefit many of their clients. That’s because the immediate tax break the old rules provided often resulted in unexpectedly high tax bills later in life — and that high earners should start saving after-tax money if they haven’t already.
At Earned, for example, our financial advisors would argue that savers should already be integrating tax diversification into their saving strategies to mitigate unknowns, such as how long employment could last and where a retiree might end up living.
Retiring late or residing in a high-tax state, for example, could make rolling pre-tax money into a new Roth account prohibitively expensive. Alternatively, retiring before 65 and falling into a lower tax bracket can be ideal timing for a pre-tax-to-after-tax conversion.
The bottom line: integrating after-tax savings into retirement saving strategies sooner rather than later has long been best practice and the new Roth 401(k) rule requiring them for high earners will likely be beneficial for many retirees.
And, if handled correctly, their savings could come out ahead in the long run—even without the usual tax break on pre-tax savings. If you’re a physician subject to this new Roth 401(k) rule and want to know what your saving options are, Earned can help. Reach out to our financial advisors today to set up a consultation.
Another benefit of Roth accounts: no required minimum distributions (RMD). RMDs required by pre-tax accounts can be notoriously tricky for retired married couples once one spouse passes away.
In these cases, RMDs continue for the surviving spouse and often bump them into higher tax brackets and result in a considerable tax burden — even as they transition from joint tax-filing status to single-filer status. RMDs also usually increase with time, which can make avoiding unnecessary tax burdens difficult.
Relying on Roth accounts instead adds greater flexibility in these scenarios. Surviving spouses choose how much to withdraw from Roth accounts (and when), giving them greater control over their retirement income and assurance that they won’t be bumped into a higher tax rate.
Roth savings are beneficial to savers and retirees in a number of other ways, as well. For instance, tax-free withdrawals from Roth accounts don't contribute to one's income, thereby sidestepping potential susceptibility to means-tested Medicare surcharges like IRMAA or the 3.8% net investment income tax.
Roth savings are also easier to access. When you begin contributing to a Roth account — even with a small sum — you trigger a crucial five-year timeline: After five years, you can start taking withdrawals without penalty. The caveat here is that the account holder needs to be at least 59 1⁄2 years old when the withdrawals happen.
Comparing Roth accounts to taxable investments reveals compelling reasons to consider post-tax savings, as well. While earnings from investments in taxable accounts, such as dividends and interest, are subjected to taxation, Roth accounts provide a haven where earnings remain tax-free.
Additionally, the sale of assets in a taxable investment account before the owner passes away results in a taxable net gain, which Roth accounts will never produce. The added benefit for Roth IRA and 401(k) holders lies in the option to withdraw their personal contributions without penalties even prior to the stipulated five-year threshold—though in the case of 401(k)s, the employer must also permit such withdrawals.
Roth accounts are a preferable choice in estate planning, as well. Recent regulations dictate that non-spouse beneficiaries of IRAs and 401(k)s, whose original owners passed away after 2019, are required to deplete these accounts within a decade of the owner's demise. That means traditional IRA and 401(k) heirs often find themselves making taxable withdrawals annually over this period.
Alternatively, beneficiaries of Roth accounts have the luxury of deferring withdrawals until the culmination of the ten-year timeframe, aligning more favorably with their financial circumstances and preferences.
Come 2026, many doctors 50 and older who are looking to save as much as possible for retirement will be required to contribute to a Roth IRA. While the loss of keeping part of their income tax-deferred may seem detrimental, post-tax savings can play an integral part in saving for retirement. We’ve written about the popular Backdoor Roth strategy on this blog before and it’s likely—given this new Roth 401(k) rule—that asset allocation will play a meaningful role in many physicians’ savings strategies going forward.
If you are a physician approaching retirement and interested in learning about ways to potentially maximize savings and understand tax implications, Earned is ready to hear from you. Our financial advisors have experience in wealth management for physicians and understanding the challenges today’s doctors may face when navigating retirement.
Contact our team to learn more about what Earned can do for you.
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