New retirement law increases tax-free savings options

Secure 2.0, the new retirement rules that lawmakers passed in late December, includes several provisions that will make the tax-free savings vehicle known as a Roth more accessible and flexible. And, in one instance, it will mandate that some higher-income earners put a portion of their 401(k) savings in a Roth account.

The value of a Roth IRA — or a Roth 401(k), which is now offered as an option in nearly 90% of employer-sponsored plans and has no income eligibility limits — is to let your money grow and then be withdrawn in retirement tax free.

Roth savings can be beneficial if you expect to be in a higher tax bracket than you are now for at least some years in retirement. And given how frequently tax laws change, having a tax-free source of money gives you more financial flexibility.

The quid pro quo: Your contributions are taxed in the year you make them. By contrast, when you save in a deductible IRA or 401(k), you get a tax deduction for your contributions the year you make them, but then pay tax on them — plus any growth from the investments you made with them — when you take the money out.

How Secure 2.0 broadens access
Here are four key Roth-related changes in the new retirement law.

Catch-up contributions for high earners: If you’re at least 50 and max out your contributions to your 401(k), you will be permitted to save an additional $7,500 in catch-up contributions

But, starting in 2024, if you earn $145,000 or more, the new law requires those catch-up contributions be treated as Roth contributions and therefore taxed in the year you make them. That would be the case even if your contributions up to the annual federal limit were made on a pre-tax basis.

Starting in 2025, the new law will raise the 401(k) catch-up contribution limits to $10,000 for anyone age 60, 61, 62 and 63.

One issue to watch this year: There is a drafting error in the law that would ban the right to make any catch-up contributions after 2024. So lawmakers either must make a technical correction in the law, or the Treasury and IRS will need to issue regulatory guidance to plan sponsors to clarify that catch-up contributions are intended to be permitted, said Brigen Winters, a principal and policy practice chair at Groom Law Group.

SIMPLE and SEP IRAs: Both SEP IRAs and SIMPLE IRAs — which are used by small businesses — are now permitted to be designated as Roth IRAs if a small business owner chooses. The provision went into in effect this year.

Employer and nonelective matches in 401(k) plans: Right now, even if you are making your contributions to a Roth 401(k), any matching contributions from your employer are still treated as tax deferred, meaning you won’t be taxed on them until you start taking distributions from your account.

The new law lets employers give plan participants the option of designating their matches as pre-tax or after-tax into a Roth account if those matches are considered fully vested. Fully vested means the money is all yours when you leave the company. Some employers let their matches fully vest within the first year or two of an employee’s tenure. Others may only treat matches as fully vested in years three, four or five.

In addition, starting in 2024, another new provision in Secure 2.0 will let employers match an employee’s student loan payments and invest those matches in a retirement account for the employee. (This can be especially helpful if employees are having trouble saving for retirement while paying off their loans.)

Again, in the case of these nonelective matches, employees may be given the choice of whether to make the match on a pre-tax basis or on an after-tax Roth basis.

Distribution rules: One of the benefits of having a Roth IRA while you’re alive is that you are not required to take annual distributions from it if you don’t want to. That is not the case if you have a Roth 401(k) — that account is subject to all the required minimum distribution rules that apply to retirees in their 70s. The only way to remedy that is to roll your Roth 401(k) money into a Roth IRA.

But, starting in 2024, your Roth 401(k) will no longer be subject to required minimum distribution rules.

That can be a benefit, Winters said, if you like the investments offered in your 401(k) plan and if they have a lower cost than what you might find if you managed your own IRA in a brokerage account.