High Earners Age 50 and Older Are About to Lose a Major 401(k) Tax Break

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One of the biggest retirement-saving perks for workers age 50 and older is about to get new restrictions.

Starting next year, the extra catch-up contributions that those workers use to stow money in their 401(k)s will have to go into their accounts after tax for high earners. The Internal Revenue Service issued final rules this month on a 2022 law, which set the threshold for a high earner at more than $145,000 in wages.

This change means many workers will pay taxes on their catch-up money upfront during high-earning years instead of in lower-earning years in retirement. The money would go into a Roth account, where it can later be withdrawn tax-free.

It is the first time the tax code is mandating Roth savings, which give the government its cut up front.

A 60-year-old in the 35% tax bracket could lose a nearly $4,000 deduction for an $11,250 super catch-up contribution. That raises adjusted gross income, which could disqualify people from other tax breaks that phase out at higher income levels, such as deductions for student-loan interest and for state and local taxes. It could also push these workers into higher tax brackets.

The worst-case scenario is for high earners who don’t have access to a Roth 401(k). They won’t be able to make catch-up contributions at all.

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The $145,000 threshold for losing the pretax catch-up option is based on the employee’s prior-year income. It is also indexed for inflation. That would mean, according to Milliman’s estimates, someone with more than $150,000 of wage income this year at one job would be limited to making Roth catch-ups next year.

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The Roth catch-up mandate also won’t apply to high earning self-employed people who don’t have traditional wages from an employer. They will be able to continue making pretax 401(k) catch-ups.

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While the Roth mandate looks harsh, for some savers it could be beneficial. “While they’re paying tax on the money today to put it in the Roth, they’ll have a tax-free retirement income stream,” says Joseph Perry, a certified public accountant with CBIZ Advisors in Melville, N.Y.

The law change could be an opportunity for savers to re-examine investments, he said. People often spread their savings among pretax, Roth and nonretirement brokerage accounts. (With brokerage accounts, interest income, dividends and capital gains are taxable.)

Many high earners have too much in pretax accounts, and are trying to save more in Roth, Perry said.

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