Options for tax-free savings are expanded by the new retirement law

The tax-free savings vehicle known as a Roth will be made more accessible and adaptable thanks to a number of provisions in Secure 2.0, the new retirement rules that lawmakers passed at the end of December. Additionally, it will require some people with higher incomes to transfer a portion of their 401(k) savings into a Roth account in one instance.

The value of a Roth 401(k) or Roth IRA, which is now available as an option in about 90% of employer-sponsored plans and has no income eligibility limits, is that it allows you to grow your money and then withdraw it tax-free in retirement.

If you anticipate being in a higher tax bracket than you are currently for at least some of your retirement years, Roth savings may be beneficial. Additionally, since tax laws change frequently, having money that is not subject to taxes gives you more financial flexibility.

The trade-off: Contributions are subject to taxation in the year they are made. In contrast, when you save in a deductible IRA or 401(k), you get a tax deduction for your contributions in the year you make them; however, when you take the money out, you pay taxes on it as well as any growth from investments you made with it.

How access is expanded by Secure 2.0

The new retirement law makes four key Roth-related changes.

Contributions to catch up for high earners: You can save an additional $7,500 for catch-up contributions if you are at least 50 and have exhausted all of your 401(k) contributions.

However, the new law stipulates that catch-up contributions will be taxed in the year they are made if you earn at least $145,000 beginning in 2024. Even if you made pre-tax contributions up to the annual federal limit, that would still be the case.

The new law will increase the maximum 401(k) catch-up contribution limits for individuals aged 60, 61, 62, and 63 to $10,000 beginning in 2025.

• This year’s issue to keep an eye on: The law would prohibit the right to make any catch-up contributions after 2024 due to a drafting error. According to Brigen Winters, a principal and policy practice chair at Groom Law Group, lawmakers will either need to make a technical correction to the law or issue regulatory guidance to plan sponsors to make it clear that catch-up contributions are intended to be allowed.

• SEP and SIMPLE IRAs: If a small business owner so chooses, SEP and SIMPLE IRAs, which are used by small businesses, can now be designated as Roth IRAs. This year saw the implementation of the provision.

• 401(k) plan employer and non-elective contributions: Even if you contribute to a Roth 401(k) at this time, any employer matching contributions are still treated as tax-deferred, meaning that you will not be taxed on them until you start making withdrawals from your account.

If plan participants are deemed fully vested, the new law permits employers to offer them the choice of depositing their matches into a Roth account either pre-tax or after-tax. Fully vested means that when you leave the company, you get all of the money. Within the first year or two of an employee’s employment, some employers allow matches to fully vest. In some cases, matches may only be considered fully vested in years three, four, or five.

Another new feature of Secure 2.0 will also allow employers to match an employee’s payments on student loans and put those funds into an employee retirement account beginning in 2024. This can be especially helpful for employees who struggle to save for retirement while simultaneously repaying their loans.)

Again, in the case of these non-elective matches, employees may be given the option of contributing either before or after taxes through a Roth account.

• Distribution rules: You are not required to take annual distributions from your Roth IRA if you do not want to, which is one of the advantages of having one while you are still alive. That is not the case if you have a Roth 401(k), which is subject to all of the 70-year-old retiree’s required minimum distribution rules. That can only be fixed by rolling your Roth 401(k) funds into a Roth IRA.

However, the rules governing required minimum distributions will no longer apply to your Roth 401(k) starting in 2024.

Winters said that if you like the investments in your 401(k) plan and they are less expensive than if you managed your own IRA in a brokerage account, that can be a benefit.