The New Rules
Last December, Congress passed a new set of rules regarding catch-up contributions for retirement accounts.
In the past, savers 50 years and older were allowed to make catch-up contributions of up to $7,500 to their 401(k) accounts. Under the new rules, people who earned more than $145,000 the previous year will only be allowed to make catch-up contributions to Roth accounts, not 401(k)s.
In 2022, roughly 16% of retirement savers took advantage of catch-up contributions, according to Vanguard.
Roth Account Benefits
Since catch-up contributions will only be allowed in Roth accounts from now on, many companies are scrambling to make Roth retirement accounts available for their employees, in addition to 401(k)s.
This rule change means that some high-earning Americans will pay more in taxes. However, financial advisers are adamant that there are still plenty of benefits to making catch-up contributions to a Roth account, since the money can be withdrawn tax-free.
Additionally, these changes won’t apply to Individual Retirement Accounts (IRAs), which, in 2023, will allow a catch-up contribution of $1,000 – in addition to the $6,500 annual limit – for savers 50 years and older.
The Bottom Line
For years, making catch-up contributions to a 401(k) was a big tax-saver for high-earners. For example, if someone paid a tax rate of 35% then they could save $2,625 on their taxes when they made a catch-up contribution of $7,500 to their 401(k). Put another way, they could simultaneously reduce their tax bill while also investing money for retirement.
This rule change will eliminate this tax trick, since they’ll now have to pay taxes up-front during high earning years as opposed to in lower-earning retirement years.
Regardless of age or income level, it’s always important to stay aware of major legislation changes like this one, which will change how many Americans plan for retirement.
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