A Quiet 401(k) Rule Change Is Forcing Workers to Rethink Their Retirement Plans

It can be hard to keep up with 401(k) rules, especially when they tend to change each year. And, this year is no different. In fact, due to the Secure 2.0 Act, there are a few new retirement plan rules that have gone into effect.

Most news stories have covered expanded 401(k) access or higher contribution limits, but a lesser-known change is affecting high earners in particular. Here is what you should know. 

The quiet 401(k) change some people missed

In 2022, Congress passed the Secure 2.0 Act, which was designed to improve access to 401(k)s and encourage more people to save for retirement. For example, the Secure 2.0 Act required employers to set up automatic 401(k) enrollment for new plans and made it possible for some part-time workers to get access to a 401(k).

There is a smaller provision in it, though, that affects high earners over age 50 who want to make catch-up contributions. Starting this year, people who earn more than $150,000 a year and are over 50 need to make catch-up contributions to a Roth 401(k) instead of a traditional 401(k).

Why this rule matters

In past years, many high earners relied on catch-up contributions not only to increase their 401(k) balances, but also as an integral part of their tax strategy. That's because catch-up contributions to a traditional 401(k) could reduce their taxable income.

However, with a Roth 401(k), employees may have to change that strategy. That's because with a Roth 401(k), employees make after-tax contributions. That means if high earners want to make catch-up contributions, the catch-up contributions won't reduce their taxable income as they have in years past.

How the new Roth rule affects pay

This rule may also affect your paycheck. Because Roth contributions work differently, you'll be taxed on your full income rather than a reduced amount. That means that eligible workers who decide to make catch-up contributions can have a smaller paycheck, even though they're making the same amount.

That can feel alarming to get a smaller paycheck, but you're still saving the same amount for retirement. It's just that instead of paying taxes when you withdraw during retirement, you pay taxes now. While this is a big change for many people, there are also benefits to making these Roth contributions.

The benefits of Roth contributions

While losing the ability to reduce taxable income may be disappointing for some, there are silver linings. For example, even though you'll make after-tax contributions with this new rule, your money grows tax-free. That's helpful when you're getting closer to retirement, and you want to maximize your savings.

Additionally, once you do retire, you can withdraw money from a Roth 401(k) tax-free as long as you meet specific requirements. That can give high earners many options, especially if they expect to be in a higher tax bracket during retirement as well.

The drawbacks to this new rule

A drawback of this new rule is that some employers may be slow to adopt it. Some companies may not even offer Roth 401(k) options, and making payroll updates might be slow. This may be frustrating to handle, especially if you want to make catch-up contributions and ensure you're following tax laws.

The other downside of this new rule is that it eliminates your ability to choose between a Roth and a Traditional 401(k). Previously, eligible employees could decide how to invest their catch-up contributions. Now they don't have that choice under this new rule.

Other 401(k) changes

Some other notable 401(k) changes include an increase to the total contribution limit. Now, you can contribute up to $24,500 a year. Those aged 50-60 can make catch-up contributions of $8,000, an increase from previous years. Those aged 60-63 can make super catch-up contributions of $11,250.

How to stay up to date

Because 401(k) rules, including contribution limits, can change each year, it's a good idea to stay up to date on the changes for your retirement plan. Make sure to read any emails you get about this topic from your employer. Ask your human resources department if you have questions, and consult a financial planner if you need help choosing the best tax strategy for you.

Bottom line

If you're over age 50 and earning more than $150,000 per year, it's a good idea to know about this new 401(k) rule. Understanding the changes happening can help you to prepare your household budget, decide how much to contribute to your 401(k), and more. Ultimately, the goal is to achieve a stress-free retirement, so staying up to date on these rules and asking questions if you need help is important.

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