Millions of high-income Americans could lose the popular 401(K) tax deduction – here’s what it means for you
Workers over 50 making catch-up contributions to their 401(K) will only be able to funnel them into a Roth account starting next year, meaning they’ll be taxed upfront rather than when they withdraw Read more: A Roth Is the 401(k) really a good idea? Finance guru issues warning
Changes to a popular 401(K) tax deduction are set to hit millions of high-income Americans starting next year.
Workers over age 50 are entitled to make catch-up contributions to their 401(K) worth up to $7,500 this year. The annual cap on all contributions is $30,000
But starting in 2024, those earning more than $145,000 can no longer put these catch-up payments into a traditional 401(K).
Instead, under new rules passed by Congress in December, the money will only be funneled into a Roth IRA account.
The main difference between a Roth account and a 401(k) pot is that the former is taxed upfront — but can be withdrawn free of charge in retirement.
Millions of high-income Americans are about to suffer a huge change in their 401(K) contributions starting next year.
With a 401(K), workers aren’t taxed on their contributions until they withdraw them.
This option is often preferable because retirees are in a lower tax band during retirement which means they pay a smaller tax – although this varies depending on income.
For example, if a worker is in the 35 percent tax bracket, they would be taxed $2,625 on their $7,500 catch-up payment.
But if they fall into the 22 percent bracket at retirement, the levy also drops to $1,650.
Experts say the change will have a major impact on America’s retirement plans. Statistics from financial planning firm Vanguard show that 16 percent of eligible workers made catch-up contributions last year.
Although many insist that this can be a good thing because employees often overlook the value of Roth accounts.
Christina Guglielmetti, a financial adviser in Brooklyn, told the Wall Street Journal: ‘The Roth is such a powerful savings tool that I try to have at least a few dollars go into that bucket for all my clients, regardless of tax bracket.’
The changes do not apply to IRAs with a catch-up contribution limit of $1,000 this year for those over age 50. All contributions are capped at $1,500
While Roth retirement pots are considered relatively controversial, their value is often underestimated.
Many people prefer the traditional 401(K) route because they assume they’ll be in a lower tax bracket in retirement.
But that’s not always the case—especially since taxes can certainly increase when a worker reaches retirement age.
Data from Northwestern Mutual shows that typical Americans currently save just seven percent of their 401(k) goals.
Investment adviser Patrick Donnelly recently told Newstimesuk.com: ‘When you’re contributing to retirement you have to consider what your taxable income is now versus what it’s going to be in retirement, but that should take into account the outlook for future tax rates.
We are in a relatively favorable tax environment today for both high and low income earners compared to historical income tax rates.’
Donnelly projects that this means that the U.S. is looking at a long period of significantly higher average tax rates in the future — which he predicts could reach a peak of 15 or 17 percent.
Experts have repeatedly sounded the alarm for America’s retirement crisis, with each generation failing to put enough money into their 401(K)s.
A recent study by the National Institute on Retirement Security found that the average ‘Generation Z’ household – those between the ages of 43 and 58 – has only $40,000 saved for retirement.
That’s 59 years old, despite the group’s oldest member being less than two years away from being able to withdraw funds from their 401(K).
And they are four years away from being able to claim Social Security at age 62. Currently, that means the group will have just $1,600 a year to look after those aged 60 to 85.
Separate data from Northwestern Mutual shows that typical Americans currently save just seven percent of their 401(k) goals.
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