Senate tax tweak would curb pretax 401(k) catch-up contributions

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Senator Orrin Hatch, a Republican from Utah and chairman of the Senate Finance Committee.

Workers over age 50 would no longer be able to make catch-up contributions on a pretax basis to their retirement plans under a new amendment to the GOP's Senate version of the tax bill.

Orrin G. Hatch, chairman of the Senate Finance Committee, filed the amendment to the bill on Monday.

The full text of the bill is here, and amendments are here.

This amendment would permit workers over age 50 to contribute up to an additional $9,000 each year to their retirement plans, but it would require that these contributions be made to Roth accounts. Those are accounts where taxes are paid upfront.

Currently, employees over age 50 can contribute up to $6,000 in additional savings each year to their 401(k) plan and do so on a pretax basis. That's on top of the current annual $18,000 limit.

Pretax versus after-tax

Assuming tax rates go up in the future, contributing to a Roth in the present and paying income taxes now may make sense if you're already in a low tax bracket.

However, employees who are now in a higher tax bracket and expect to bring in far less income in retirement may be at a disadvantage if they're saving catch-up contributions in Roth accounts.

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"The impact of taking away pretax contributions doesn't affect really wealthy people," said Aaron Pottichen, president of retirement services for CLS Partners.

"It affects those in the middle who make enough money to use the catch-up, but still need to contribute on a pretax basis to accumulate more money now," he said.

There were $660 billion in Roth IRA assets at the end of 2016, the most recent period available by the Investment Company Institute.

In comparison, savers hold $7.5 trillion in all workplace defined contribution plans as of June 30, according to the Investment Company Institute.

Other retirement plan tweaks

Senator Hatch also filed an amendment to the bill to eliminate Roth "recharacterizations," or do-overs of Roth IRA conversions.

Since you pay income taxes in the present on the amount of money you convert to a Roth, a conversion may bump your taxable income into a higher bracket.

Recharacterizations allow you to undo these transactions and spare you the taxes.

The House bill had a similar measure, so savers may want to think about taking these do-overs while they're still available.

Separately, the Senate bill also eliminates employees' ability to make catch-up contributions to their retirement plan for a year if they received wages of $500,000 or more for the prior year.