Paper Trails

What are the new 401(k) catch-up rules?

As we anticipate the arrival of 2024, it is crucial for businesses to stay informed about any legislative changes in order to maintain compliance for both their business operations and their employees. We understand the importance of staying ahead of the game at Paper Trails, which is why we are dedicated to keeping businesses like yours up to date with any rule changes that may impact you. In light of the legislation that was passed last December, there are new rules to the 401(k) catch-up specifically aimed at high-earning Americans. These changes are significant and may have a direct impact on your employees’ retirement plans.

At Paper Trails, we take our role as industry experts seriously. By reading the article, you will gain a thorough understanding of the new IRS 401(k) catch-up rules and be able to identify which of your employees may be affected by these adjustments. Our goal is to provide you with the knowledge and tools necessary to navigate these changes seamlessly, ensuring that your business remains compliant and your employees are well-informed.

What are 401(k) catch-up rules?

So, before we dive into the new rules surrounding 401(k) catch-ups, let’s take a closer look at the current 401(k) regulations. Each year, eligible employees have the opportunity to contribute a specific dollar amount on a pre-tax basis to their retirement accounts. For those who actively save for retirement through a 401(k) plan, they are allowed to set aside a maximum of $22,500 in the year 2023.

However, for employees who are 50 years old or older, there is an opportunity to add an additional $7,500 to their retirement savings in 2023, known as a “catch-up” contribution. It’s important to note that previously, all employees who were 50 and older could contribute this extra catch-up amount on a pre-tax basis. However, there have been recent changes to the rules that impact certain employees.

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What are the new 401(k) catch-up rules?

Starting from next year, individuals who earned more than $145,000 the previous year will have their catch-up funds directed exclusively towards after-tax Roth accounts. This change will require many workers to pay taxes on their catch-up money upfront during their high-earning years, rather than during retirement when they might be in a lower tax bracket. As a result, this alteration has the potential to reshape the way Americans save for retirement.

With this new regulation, high earners will now have the opportunity to take advantage of the benefits that come with after-tax Roth accounts. Not only will their catch-up contributions be tax-free upon withdrawal, but the funds within the Roth account can also grow tax-free. This means that individuals can potentially accumulate even more wealth for their retirement without having to worry about paying taxes on their investment gains.

While it’s true that some Americans may have to pay more in taxes under the new regulations, the benefits of having funds in a Roth account can often outweigh the potential drawbacks. Not only do Roth accounts offer tax-free growth and withdrawals, but they also provide individuals with more control over their retirement savings. With a Roth account, individuals can choose when and how they want to withdraw their funds, giving them the flexibility to adapt their financial strategies as their needs evolve.

It is important to note that these changes do not apply to IRAs. However, for those who are eligible for catch-up contributions and earn more than $145,000, the after-tax Roth accounts offer a new and enticing option to grow their retirement savings and secure a financially stable future.

What are the benefits of these new 401(k) catch-up rules?

Roth accounts offer specific advantages that retirees can benefit from. Unlike traditional accounts, which require retirees to pay ordinary income tax when they withdraw money, Roth accounts enable workers to accumulate tax-free savings. This allows them to have a financial cushion in years where accessing other accounts could potentially push them into a higher tax bracket or result in higher Medicare premiums.

Moreover, Roth accounts offer retirees the flexibility to effectively manage their tax liability during retirement. By strategically combining taxable and tax-free savings, retirees have the opportunity to strategically withdraw funds from their accounts and minimize their overall tax burden. This can be especially advantageous for individuals who have substantial balances in traditional 401(k)s and individual retirement accounts, as they can strategically tap into their Roth accounts to avoid remaining in the same or even a higher tax bracket in retirement.

Additionally, it’s crucial to note that assuming a lower tax bracket in retirement isn’t always accurate. Many high earners accumulate significant balances in traditional 401(k)s and individual retirement accounts, which could result in them staying in the same or even a higher tax bracket when they begin withdrawing funds in retirement, as required by the Internal Revenue Service.

Finally, Roth accounts provide a superior option for diligent savers compared to taxable brokerage accounts. Unlike taxable brokerage accounts, where owners must pay taxes annually on dividends, interest, and capital gains, Roths grow tax-free. This allows individuals to maximize their savings potential and can significantly impact the growth of retirement savings over time, providing retirees with a greater sense of financial security.