One aspect of financial planning is considering the tax impacts of investment decisions. New rules for catch-up contributions, as shown in Anne Tergesen’s article, “High Earners to Lose A 401(k) Tax Break”, will change the tax impact for savers, especially those in higher tax brackets. Earners saving for retirement, ages 50 and over, are able to make additional contributions to their 401(k)s annually. Next year, these catch-up contributions must go into a Roth IRA account. The old rules allowed taxpayers to avoid paying taxes on these contributions at their current, higher tax rate and pay taxes on the earnings in retirement, when they will hopefully have lower tax rates. They could also take a deduction on these contributions. Now, the taxes must be paid upfront, and taxpayers lose this deduction. This means the contributions will be taxed at the earners current tax rate, not favorable for those in higher tax brackets, and they do not get tax saving in their current year.
However, there are benefits to this money being put into a Roth IRA. The biggest advantage is that any growth from the Roth IRA is tax-free. So, while this change may decrease tax savings in the current year, there would be no tax eating away at the realized Roth IRA investment in retirement. These changes are set for next year, but many have asked for delay to address some complications that these new rules pose. Some companies have to rework their systems to ensure the catch-up money in going into a Roth. Other companies did not previously have a Roth as an option for employees, which if unchanged, would cause those workers to forfeit any catch-up contributions. Companies are also unsure if under these new rules if they still need to ask permission to put this money into a Roth, or if it can be done automatically.
Time will tell the true impacts of these new rules, but it will certainly have an impact on strategic planning for retirement.
Questions on this article or to find out more, e-mail Brien@TraditionsWealthAdvisor.com or visit: https://www.wsj.com/articles/retirement-tax-breaks-401k-contributions-2868ffdc