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  • Writer's pictureBridget Sullivan Mermel CFP(R) CPA

New IRS Rules for Catch-Up Contributions and Their Potential Impact

John and Bridget discuss the new rules introduced by the IRS regarding catch-up contributions for individuals over the age of 50. The rules state that if you are over 50, you can put extra money into your 401(k) to catch up on retirement savings. However, starting in 2026, if your income is over $145,000, you can only make catch-up contributions to a Roth 401(k), not a traditional one. The speakers discuss the implications of this change and potential tax planning opportunities.

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John: The IRS recently introduced new rules for the 401K catch-up contributions for people over age 50. In this episode of Friends Talk Financial Planning, we'll talk about what those new rule changes are and how they might affect you. Hi, I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin.

Bridget: And I’m Bridget Sullivan Mermel, and I've got a fee-only financial planning practice in Chicago, Illinois. And before we start talking about the Secure Act regulations, please subscribe. It helps our YouTube algorithms and helps more people find us. So John, let's talk about the new rules that IRS put out. But first, tell us about the Secure Act 2.0 and why these rules were even necessary.

John: Well, yeah, I'm going to take a step back. I'm sure people hear IRS rules and catch-up contributions, and think, “What could be more entertaining?” But it’s important to know what's going on here, and we tend to throw these terms around. I don't think that catch-up contributions are too much financial jargon, but we have to be clear. We’re not talking about the kind of sauce you put on your hot dogs or hamburgers. I guess you don't put them on your hot dogs in Chicago.

It's not catch up that way. It's catching up. That rule has been in place for a while now, and what it says is that if you're over age 50, then you can put extra money into your 401K. And the reasoning was, hey, if you didn't do it when you were in your twenties and thirties but now you're in your fifties and sixties and you got to make up for lost time. It allows you to put extra in to be able to catch up with what you maybe should have done previously.

So it's an extra amount. I think the number for this year is $7,500 extra you can put in your 401K plan if you're over age 50. I've always got to look those rules up, but luckily, they're easily accessible. But listen, I can put that amount in addition to the regular contributions because I'm over 50. I can put an extra $7,500 in to help me catch up with my retirement savings. So that's what we're talking about. We talk about this catch-up contribution.

Bridget: Yeah. And when I did the calculation, my estimate is that adding that extra $7,500 in 401K if you've got the money available to do it saves people between, say, $1,500 $4,000 a year.

John: Yeah. Depending on your tax bracket.

Bridget: Yeah.

John: Thanks for saying that because when there's extra money, people might say, “All right, I want to save more than the regular 401K amount. I'm going to put that money somewhere because I need to get ready for retirement.” We're able to do it in the 401K plan with this catch-up provision. Okay, awesome. By putting it in there, I get a tax deduction when I put money in my 401K plan.

And by doing that, I save a couple thousand on taxes this year. My tax bill goes down. If I want to save for retirement, I can do it on a tax-deductible basis, and life is good. So that's the foundation. That's what things looked like in the past. When the Secure 2.0 act came out last year, it said, “Listen, if your income is over a certain amount, when you make that catch-up contribution, the only way you can do it is via Roth 401K, not regular.

And what that means is that when you put it into Roth, there's advantages in taxes, but you don't get the tax deduction today. Instead, in the future, when you take it out, there're no taxes. So to your point exactly, Bridget, what you lose today is that $2000, $3,000 tax deduction, but you get the promise of lower taxes in the future. And so that's where this started is the new law. Secure 2.0 says you can do the catch-up, but it has to be Roth 401K so that we get that tax money today.

Bridget: Correct. And that was supposed to start in 2024.

John: Yeah. They passed the law last December, and then they said, “Okay, we got this year to figure out and get ready for 2024.” And I think what really happened is that in the industry, the people that run the 401K plans effectively complained and said, “Jeez, this is a big burden to make these changes and to figure this stuff out.”

At the end of the day, what the IRS did with that is they came out here just a week or two ago as we're recording this, and said, “Listen, that rule is going to stay in place. The number is $145,000. If your income is over $145,000 from your salary, then you can't do a regular catch-up contribution. You can only do Roth, but we're going to push it off instead of it starting next January in 2024, it's going to start in January of 2026.” So they kicked the can down the road two years.

Bridget: Not even just 2025. So they gave both the companies and the 401K providers a lot more time. The other curious thing to me is that I believe there'll probably be tax legislation in 2026. The current tax regime expires right around then. And so it could be in that mix, too. It's possible, again, based on the complaints.

I saw this years ago when they wanted to change the mileage rate in the middle of the year because gas prices were so high, so they wanted to reimburse people more for their mileage through their taxes. And a lot of people couldn't get their head around this. It was going to be so difficult. So again, the IRS just gives people more time and then lets the upper die down, and they look like nice people.

John: Yeah, that's right.

Bridget: The people at the service.

John: The big news is: what's changed? Really nothing has changed with the law, but it gets pushed back a couple of years. And as you said we've got tax law changes coming in 2026. If Congress doesn't do anything, the law goes back to the old law back in 2015 or 16. Tax rates go back to the old regime. So there's going to be a change one way or another whether it goes back to the old way or they make a change today.

Plus, we're going to have this 401K catch-up contribution tax change kicking in at the same time, so there could be some interesting planning opportunities come the end of 2025 and into 2026. Speaking of that, let's talk about some tax planning opportunities or what comes with this particular rule. We can't do anything about it right now. It was going to be, “Hey, let's get ready for next year,” but now it's “Let's get ready for 2026.” But what's your take on this change from it being a tax-deductible catch-up contribution to it being a Roth contribution if your income is over $145,000?

Bridget: Well, in general, $145,000 by itself does not imply a high tax bracket. However, I think that over $145,000 implies a lot of people in high tax brackets. And we looked up the numbers and if you're single, $145,000 is actually kind of a high of a tax bracket, but if you're married $145,000 and $145,000, or $290,000 is not that high of a tax bracket. So my point is that it depends on where your income is and it depends on where you're at.

So some people are super savers and they want to save as much money as possible. And I love the tax break for that. The $2,000 to $4,000 a year that you get on putting the catch-up contribution in, it's like a bird in the hand. That tax break in the hand is worth a lot of taxes in the future. There's a lot of talk that taxes are going to go up. Oh, do X, Y and Z because taxes are going to go up.

And so much of it never comes to pass because the politicians are playing that game that we all played when we were kids called kick the can. They're kicking the can down the road. And so, I have heard taxes are going to go up a lot, and I have seen it a few times, but I don't see it that often because it's hard to do politically.

John: Yeah. In the past 20 years, there have not been many tax increases.

Bridget: Right.

John: I take a little bit of a different approach. I'm all about taking tax deductions today. I think part of it is that we just don't know what the benefit is. I do like that bird in hand theory, but it's one of those for me where I like to ask, “What's actionable on things.” And over the years, our conversations often result in us waying, “We'll figure out what to do when the tax law changes, not anticipate what we think that the tax law might possibly be if something maybe happens.”

And so you go, “Listen, what can we do today?” The reality of this is that starting in 2026, there is no other option. If you want to save more than the 401K regular limit, you can either put it into the bank account or into a brokerage account, or you can do this catch-up thing, but you have to do it the Roth way. Do I like the tax deductible one better? Maybe, maybe not. I'm a little bit more up in the air. But the reality is it doesn't make any difference. There's no choice if my income is especially significantly over $145,000.

The deal is if I want to save some money, I'd rather save it in Roth than in the brokerage account for tax purposes. You go, “Okay, it is what it is.” So from that standpoint, there's less about what to do. One place where I do see that there could be some opportunities are if your income, and this is per person, because they look at your wages, is really close to that $145,000, maybe there are some things that you say, “Listen, I'd like to get below that, so I can take that tax deduction.”

For example, for people like you and I who run our own businesses, though the difference between $130,000 or $150,000 hasn't made a whole lot of difference in the past, now I might go, “Listen, I want to go back and take a look at that market data and make sure that I'm exactly in the right place because maybe a few thousand dollars one way or another where it didn't make a difference before from tax standpoint, maybe it would make a difference here. So I'd be smart about that. Yeah, that's one of the places anyway.

Bridget: And for people in that range, it'll be very interesting to see what the final regulations are. Does the $145,000 already include what you put into the 401K? So is it effectively $145,000 plus whatever it is? $22,500?

John: Right. Some of those rules haven't been figured out. We will have to wait until they pass the law. We don't exactly know those things.

Bridget: Right. But that's actually pretty significant. That'll be interesting to see how that plays out.

John: I was just going say to the other place where it comes like it's when you run your own business, you have some control. If you're a regular employee, you're getting a paycheck every two weeks and say your salary is right around that number. Maybe you're in a position where you say, “Hey, I'm near retirement and working 90% of the time would be appealing for my other goals, or 80%. I'm going to go four days a week.” And if that gets me under the $145,000 and it fits the rest of my financial planning, then you go, “Hey, maybe there's an opportunity there to do something.”

So there are some places but golly, if your income is way below or way above it doesn’t really matter. If your income is $200,000, you're not going to take a pay cut to get underneath and save $2,000 in taxes. So if you're close to that, pay attention. If you're way above or way below, it's probably not significant. You got to be aware of it, but it’s not actionable. And I think that's maybe a great place to wrap up here with things. So, again, I'm John Scherer. I run a fee-only financial planning practice in Middleton, Wisconsin.

Bridget: And I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago, Illinois. John and I are both taking new clients on right now, but if you're in another area and would like to speak with a local advisor we're both members of ACP or the Alliance of Comprehensive Planners, and there're members all over the country who are fee-only comprehensive, tax-focused financial planners. And with that, I'm going to say goodbye.

John: All right. Don't forget to hit that subscribe button.

At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.

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