High earners could soon lose a tax break from this 401(k) change

The Secure 2.0 Act of 2022 mandates a significant change for 401(k) catch-up contributions starting in 2026, requiring individuals earning over $145,000 from their employer in the prior year to make these contributions as after-tax Roth. This eliminates the pre-tax deduction option for higher earners, shifting their catch-up savings to a tax-free growth model. Experts advise immediate multi-year tax planning for affected individuals to determine whether to accelerate pre-tax catch-up contributions through 2025 or embrace Roth contributions sooner, impacting wealth management strategies for high-income clients.

Analysis

The Secure 2.0 Act of 2022 introduces a significant change for 401(k) catch-up contributions, mandating that workers earning over $145,000 annually from their employer must make these contributions as after-tax Roth starting in 2026. This eliminates the traditional pre-tax deferral option for higher earners, shifting their catch-up savings to a tax-free growth model. Currently, through 2025, eligible workers can still choose between traditional pre-tax or Roth catch-up contributions, with limits up to $23,500 generally, and $7,500 or $11,250 for older cohorts.

This regulatory shift necessitates proactive financial planning, particularly for those earning above the $145,000 threshold. While traditional deferrals offer an immediate tax break, Roth contributions provide tax-free growth and withdrawals, influencing long-term tax liabilities. Experts advise multi-year tax projections to determine the optimal strategy, such as accelerating pre-tax catch-up contributions through 2025 or adopting Roth contributions sooner.

Despite nearly all retirement plans offering catch-up contributions, only 16% of eligible workers utilized them, according to a 2025 Vanguard report. The report also indicates that most catch-up participants earned $150,000 or more, highlighting the relevance of this rule change to a specific, higher-earning demographic. The overall sentiment is moderately negative and cautious, reflecting the complexity and potential tax implications for affected individuals.

Key Decisions for Investors

• High-income investors (earning >$145,000) should immediately consult with financial advisors to conduct multi-year tax projections to understand the implications of the mandatory Roth catch-up contributions starting in 2026.
• Consider maximizing traditional pre-tax 401(k) catch-up contributions through 2025 if current tax brackets are higher than anticipated future retirement brackets, leveraging the remaining window for upfront tax deductions.
• Evaluate the long-term benefits of Roth contributions, including tax-free growth and withdrawals, especially if future tax rates are expected to be higher, aligning with the new mandate for high earners.