This lesser-known 401(k) plan change will soon strip higher earners of a tax break

Higher earners maximizing savings up of status whitethorn soon suffer a taxation break, acknowledgment to 401(k) changes enacted past year.

If you're 50 oregon older, you tin funnel other wealth into your 401(k), known arsenic "catch-up contributions." For 2023, eligible workers tin prevention different $7,500 aft maxing retired employee deferrals astatine $22,500.

But starting successful 2024, higher earners tin lone marque 401(k) catch-up contributions to after-tax Roth accounts, which don't supply an upfront taxation interruption but the funds tin turn levy-free.

The 2024 displacement applies to idiosyncratic accounts, meaning workers who gain much than $145,000 successful 2023 from a azygous leader tin expect to spot the change, experts say.

"This alteration has already started to make administrative turbulence for employers arsenic they program for the January 1, 2024 implementation date," said certified fiscal planner Jim Guarino, managing manager astatine Baker Newman Noyes successful Woburn, Massachusetts. 

"In addition, it whitethorn besides origin high‐earning employees to rethink their determination to marque catch‐up contributions aft 2023," said Guarino, who is besides a certified nationalist accountant.

Some 16% of eligible employees took vantage of catch-up contributions successful 2022, according to a caller Vanguard report based connected astir 1,700 status plans. 

A abstracted Secure 2.0 change starting successful 2025 boosts catch-up contributions by 50% for employees aged 60 to 63.  

Guarino urges higher earners to money pre-tax catch-up contributions successful 2023 portion they inactive tin due to the fact that it provides a bigger taxation break.

For example, let's accidental an worker makes a $6,000 catch-up publication portion successful the 35% taxation bracket. If they retreat the $6,000 successful status portion successful the 15% bracket, they've saved $1,200 successful taxes, helium said.

Alternatively, if the aforesaid worker makes a $6,000 Roth contribution, they're paying upfront taxes successful the 35% bracket, which means paying taxes astatine a 20% higher complaint upfront, Guarino said.

"There are galore advantages to Roth status accounts," Guarino said. "However, being successful a little taxation bracket during status is not needfully 1 of them." But determination whitethorn beryllium different reasons for boosting Roth contributions — similar avoiding required minimum distributions. 

While immoderate higher earners volition suffer a taxation break, the catch-up publication alteration is "not needfully a atrocious thing," according to Dan Galli, a CFP and proprietor astatine Daniel J. Galli & Associates successful Norwell, Massachusetts. "There's immoderate diversification from a taxation constituent of view."

Of course, erstwhile comparing pretax and Roth 401(k) contributions, the champion enactment depends connected your idiosyncratic goals, expected income taxation brackets successful status and different factors. "I'm a large instrumentality of hedging and diversifying," said CFP John Loyd, an enrolled cause and proprietor astatine The Wealth Planner successful Fort Worth, Texas.

Galli is pushing higher-earning clients to acceptable up Roth idiosyncratic status accounts up of the change. The reason: Investors with Roth 401(k) funds whitethorn privation to transportation the wealth to a Roth IRA successful retirement.

Otherwise, they'll person to woody with the alleged "pro-rata rule," which requires you to instrumentality some pre-tax and after-tax wealth with 401(k) withdrawals, Galli said.

Instead, helium prefers retired clients to support pre-tax and after-tax wealth successful antithetic IRAs. "You get much power successful status if you tin segregate your wealth by its taxation character," helium said.

However, with less than six months until 2024, galore companies are struggling to update status plans by the deadline. Roughly 200 organizations wrote a letter to Congress asking for much clip to instrumentality the changes.

Some 80% of status plans offered Roth contributions successful 2022, according to Vanguard, compared with 71% successful 2018.