The alternative of tax-free growth will serve a lot of people better. When required minimum distributions begin at age 73, it could be the case that you're in the same tax bracket. However, this isn't always the case - especially for high earners who've racked up large 401(k) and traditional IRA balances. People often choose a regular account over a Roth because they expect their tax bracket to be lower in retirement, so they'd rather pay taxes on the backend. For instance, if you open an account in July 2023, your five years will be up on Jan.
Your five-year clock begins at the beginning of the tax year when you first open your account. To be eligible for tax-free withdrawals from a Roth 401(k), you must be 59 1/2 years old and have had your account for at least five years. The savings from the roughly $12,000 in capital gains you'd typically owe taxes on will outweigh the taxes you paid to contribute the initial $7,500. For example, a one-time $7,500 investment could grow to around $19,400 in 10 years averaging 10% annual returns. On the surface, paying taxes on catch-up contributions seems unfavorable, but the potential backend benefits of tax-free withdrawals often cancel it out. The goal isn't to "fix" this, but the new change could be more beneficial than it appears. With a $7,500 catch-up contribution, someone in the 35% tax bracket would essentially receive a $2,625 tax deduction, while someone in the 24% bracket would get a $1,800 deduction. Can the new change actually benefit you?Īs it stands, pre-tax 401(k) catch-up contributions benefit people in higher tax brackets more. What are the 5 Best Places to open a Roth IRA I explain in this video what you should be looking for, and suggest some options for you Links: Hump Days. For example, if you currently take home $150,000 annually after taxes and decide to contribute the max $7,500 catch-up contribution, your new take-home pay would be $142,500. With a Roth 401(k), the amount of your contributions will decrease your take-home pay by that exact amount. In a regular 401(k), your contributions don't have a 1:1 effect on your take-home pay because your tax bracket is calculated after you make contributions. Like regular 401(k)s, Roth 401(k)s are employer-sponsored, and contributions are automatically taken from your paycheck.
If you're eligible to contribute to a Roth IRA (it has income limits), you can make your $1,000 catch-up contribution. First, the new rule change does not apply to Roth IRA catch-up contributions. Roth IRAs and Roth 401(k)s work the same tax-wise, but they have some key differences. In Roth accounts, you contribute after-tax money in return, your money grows tax-free with tax-free withdrawals in retirement.
Retirement accounts like 401(k)s and traditional IRAs give you a tax break upfront, allowing you to lower your taxable income. They'll have to go into an after-tax Roth account instead. People earning over $145,000 in the previous year will no longer be able to add their catch-up contributions to their pre-tax 401(k) account. Although catch-up contributions will remain, high earners will see a change in how they work starting in 2024.
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