Last fall, the Internal Revenue Service (IRS) announced it was increasing the amount limits one can contribute to retirement savings to help counter a financial year troubled by turbulent markets and historically high inflation, consumer price and cost-of-living indexes.
The maximum contribution that an employee can make to a 401(k) jumped $2,000 to $22,500, but workers over 50 years of age can contribute an extra $7,500 into their accounts — for a total of $30,000 — through the attractive catch-up contribution tax provision.
However, starting in 2024, workers who make over $145,000 the previous year will have their catch-up increases diverted into after-tax Roth IRA accounts as part of retirement system changes made by Congress in December, The Wall Street Journal reported.
Will You Win or Lose?
Although Vanguard Group stated only 16% of eligible 401(k) account holders use catch-ups, squirrelling away more pretax money in your 401(k) has proven to be an advantageous strategy for high-earning employees over 50.
Using the WSJ’s example, “Someone in a 35% bracket would receive a $2,625 tax deduction for a $7,500 catch-up contribution, while someone in the 22% bracket would deduct $1,650.” Depending on when you start making catch-up contributions, how many years you do and when you retire, the earnings on your catch-up contributions could be pretty significant.
The concern for savers earning more than $145,000 is that they’ll lose by paying taxes on catch-up funds while they are working and in a higher tax bracket, rather than when they are retired and potentially in a lower one.
All workers over 50 will need to review their tax planning and some may lose out and pay more taxes, but experts feel that increasing contributions to Roth accounts will set them up nicely for tax-free growth and withdrawals (the new rules don’t apply to IRAs, so, if you’re at least 50 by the end of 2023, you may set aside an extra $1,000 in your IRA, for a total of $7,500).
“The Roth is such a powerful savings tool that I try to have at least some dollars going into that bucket for all my clients, regardless of tax bracket,” Brooklyn, N.Y. financial advisor Cristina Guglielmetti told the WSJ.
Many high-earners will actually benefit for the new contribution changes and may not end up changing tax brackets when they retire, said Ed Stott, a retirement accounts advisor. In fact, because they grow tax free and are favorable to inheritors, these requirements may be “a gift to high earners,” said Stott.
The Case for Delayed Application
While the legislation — which includes new incentives to save and a later age to start required minimum requirements — will be implemented on Jan. 1, 2024, some companies are worried they won’t have enough time to make the necessary changes to their payroll systems.
As the WSJ reported, in a recent letter sent to Congress, more than 200 401(k) record-keepers, payroll providers and companies like Delta Air Lines, Anheuser-Busch and Fidelity Investments — who administer 24,800 corporate retirement accounts for employers — requested these contribution changes be delayed by two years.
“For many of these plans, unless this requirement is delayed […] their only means of compliance will be to eliminate all catch-up contributions for 2024,” the letter said.
Regulatory guidance on whether permission is required from high earners to roll their contributions into a Roth or if funds can be moved automatically is due to be announced. However, if that guidance comes too late in the year, the worry is that many companies will have to scramble to reset their employee payroll structures.
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