Two months ago, the Internal Revenue Service released its final Roth catch-up regulations, confirming that highly paid employees who wish to make catch-up contributions in 2026 and beyond can make them only to a Roth 401(k) account.
The rules, originally set to take effect in 2024, apply to those who had more than $145,000 (indexed for inflation) of prior-year W-2 wages. If an employer plan does not allow Roth contributions — although most do — these highly paid employees cannot make any catch-up contributions.
This is a significant policy change, according to Jane Ditelberg, director of tax planning for The Northern Trust Institute and author of the Tax News You Can Use blog series. She expects that many financial advisors will be asked about it in the new year.
Directing the extra contributions to a Roth account, as Ditelberg observed, means that workers are giving up an immediate income deduction and, in turn, could find themselves in a higher tax bracket.
While these taxpayers will benefit from not paying taxes on the future income, Ditelberg noted, the policy limits higher earners' ability to be strategic when deciding where to place their catch-up contributions.
When Roth Makes Less Sense
In some cases, she said, retirement savers would be better served not directing catch-up money into a Roth account.
"For example, in situations where they expect to utilize the funds sooner than later or are worried about exceeding a key income threshold,” Ditelberg said.
Generally, a Roth IRA must be open for five tax years before earnings can be withdrawn earnings tax- and penalty-free. The contributions will be available for withdrawal before age 59.5 without triggering taxes or penalties, Ditelberg acknowledged, but a potentially significant amount of earnings will not.
“This issue comes up quite a bit as I’m meeting with our planning professionals and their clients with respect to incoming tax policy changes,” Ditelberg said. “If they’re worried about this issue and the short-term and long-term tax implications, one potential strategy is to consider skipping the Roth catch-up contribution and deploying the funds into a health savings account. This route can offer added flexibility versus the Roth.”
The Virtues of HSAs
Under current law, a taxpayer can draw funds from an HSA for any reason. If the withdrawal is not for a qualified medical expense, Ditelberg noted, then the withdrawal is subject to income tax and an additional 20% penalty.
Once taxpayers turn 65 or become disabled, however, the rules change, and the HSA starts to look more like a normal savings account. Withdrawals for qualified medical expenses remain untaxed, but withdrawals for non-QMEs are subject to income tax but no additional penalty.
“This extra flexibility after age 65 makes an HSA an attractive retirement savings vehicle, especially since a taxpayer can contribute an additional $1,000 per year to an HSA after age 55,” Ditelberg said. “The taxpayer gets the benefit of excluding the contribution from their income, tax-free growth and tax-free withdrawal if used for a QME.”
As noted, for withdrawals for another expense after age 65, the only tax cost is the income tax. So, it could be a particularly relevant strategy for clients with substantial earnings in their early 60s.
“These features make HSAs an important tool to consider as part of an affluent client’s overall retirement income strategy,” Ditelberg said. “If they are already participating in a high-deductible health plan, it can make a lot of sense to steer catch-up funds in this direction.”
Managing the HSA
As Ditelberg observed in a recent blog post, an HSA can be held either as a savings account or an investment account. Choosing which type of account largely depends on the risk appetite of the taxpayer.
Interest-bearing savings accounts offer the lowest return but have the advantage of being liquid in the event of unexpected health expenses. HSA funds that are invested, conversely, carry market risk, and invested funds are generally less liquid. Emergency medical expenses, then, may require the sale of investments at inopportune moments.
Of course, investing also offers potentially greater asset accumulation. And no matter which account type is used, Ditelberg said, income from dividends and interest as well as invested assets' growth are tax-free — so long as any funds withdrawn are used for qualified medical expenses.
Other Considerations
In addition to the individual HSA or Roth options, Ditelberg noted, in some cases where a full household is being considered, it might even make sense to direct “extra funds” to another person’s HSA — usually an adult child.
Current law permits children to remain on their parent’s health insurance plans until they reach age 26. In addition to having access to cheaper health insurance than they might have secured on their own, she explained, this also creates a potential planning opportunity for young adults to open and contribute to their own HSAs. If they start early and have no major health issues, an HSA that earns even modest investment returns can grow into a substantial sum.
Individuals covered by a parent’s high-deductible health plan who cannot be claimed as a dependent on the parent’s income tax return can contribute to their own HSA up to the family maximum limit or $8,550 for 2025, Ditelberg said.
“Parents or any other family members are also allowed to make contributions to the individual’s HSA, allowing the individual to invest their own funds into other vehicles such as an IRA or an investment account,” she noted. “Additionally, the individual can claim a tax deduction for any HSA contributions they make, or that are made by any other person on their behalf, on their tax return.”
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