Policy Change Ahead: High-Earners’ 401(k) Catch-Up Contributions to Lose Tax Deduction in 2024

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This week’s insight delves into a bit of bad news for a certain group of savers nearing retirement age.

Starting next year, high-earning Americans will lose the tax deduction they currently enjoy for catch-up contributions in their 401(k) accounts. Currently, individuals aged 50 and older can contribute an additional $7,500 annually to their pre-tax employer-sponsored plans. However, beginning in 2024, this privilege will only be available to workers earning below $145,000 in the previous year. Why did Congress make this policy tweak?

It all has to do with sweeping retirement plan reforms announced last December. To pay for the overhaul, the government wants its hands on some of your money sooner rather than later. By disallowing individuals above the income threshold from taking a current-year tax deduction, it effectively forces high earners to pay more tax today. This change will result in some workers (16% of eligible employees, according to Vanguard) paying tax on their catch-up money upfront during their high-earning years, rather than waiting until retirement when they might be in a lower tax bracket. There’s a silver lining here, though.

You can still make retirement account catch-up contributions in Roth form. While you must fork over more tax to Uncle Sam, Roth investments in your plan can then grow tax-free forever. That could be good for you and your heirs. (Both Roth and traditional 401(k)s must be liquidated over 10 years by most non-spouse beneficiaries.)

It’s key to recognize that the new rule might not be adopted quickly by corporations; some firms have even requested a 2-year delay to comply, but that could mean catch-up contributions could be nixed altogether in some plans in order to meet the new standards. Finally, there are no adjustments to how IRA catch-up contributions will work.