Catch-up contributions soon taxable if wages exceed $145K: Planning for this change

Employees with wages exceeding $145,000 in 2023 may hesitate to make catch-up contributions next year. They’ll be impacted by tax changes, as will employers.

To complicate matters, there are still many unanswered questions about the tax changes, which the Secure 2.0 Act of 2022 put in place.

Needless to say, this won’t make planning for 2024 any easier for Finance pros. For example, you may offer an employer match for employees’ contributions and even their catch-up contributions to retirement plans. Consider this: Next year, will the amount your company can deduct on its federal income tax return for employer contributions change significantly?

Pre-tax deductions from wages

Here’s a closer look at Section 603 of the Secure 2.0 Act.

According to Section 603, if employees have wages that exceed $145,000 in one year, any retirement plan catch-up contributions they make in the following year will need to be made to Roth accounts. In other words, Payroll will set up pre-tax deductions from their wages for this.

High-wage earners will pay federal income tax on the full amount of their catch-up contributions.

Some industry groups are anxiously awaiting IRS guidance and have asked for relief regarding Section 603 of the law.

Here are two examples:

First, in a June 7, 2023, letter, the American Benefits Council sought a delay in the effective date of the Roth catch-up requirement and asked IRS to take action over the summer.

For one thing, employers need time to update their payroll systems so they function in sync with their retirement plans. Plus, some companies may not currently offer a Roth option, and either that would need to be added to their plans or all their catch-up contributions would need to be dropped, the council stated.

Second, the ERISA Industry Committee (ERIC) sent a letter to IRS on June 8, 2023. ERIC raised questions such as how midyear new hires should be handled and whether plan sponsors could require that all contributions be made to Roth accounts.

Given the significant operational challenges brought about by Section 603, IRS should prioritize transition relief as well as guidance, ERIC relayed.

Higher limits

In 2023, employees age 50 or older can make $7,500 in catch-up contributions to the following plans:

• 401(k) – other than a SIMPLE 401(k)
• 403(b)
• SARSEP, and
• governmental 457(b).

Section 109 of the Secure 2.0 Act contained some good news about catch-up contribution limits, namely for employees who are age 60, 61, 62 and 63. Starting in 2025, employees who are these ages will be able to set aside more of their money from their wages – although those who are high-wage earners would be doing so on a pre-tax basis.

The new limit for employees in that age range making catch-up contributions will be the greater of:

• $10,000, or
• a 50% increase over the annual catch-up contribution limit as announced by IRS.