It may seem like a negative change, but there’s a huge silver lining.
There’s a reason higher earners don’t always rush to save for a retirement in a Roth account. Once your income reaches a certain point, you may prioritize the up-front tax break that comes with funding a traditional IRA or 401(k) plan.
If you’re 50 or older this year, you’re eligible to make catch-up contributions in your IRA or 401(k). And if you have a workplace plan, your preference may be to do that catch-up in a traditional 401(k).
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Thanks to a new rule, that may not be an option. But having to fund a Roth 401(k) may also not be such a bad thing.
The rules have changed
It used to be that workers 50 and older could make catch-up contributions in a traditional 401(k) regardless of income. Now, people earning $150,000 or more will be limited to making 401(k) catch-ups in a Roth account.
So let’s say you’re 52, you make $250,000, and you want to contribute the maximum to your 401(k) this year. You can make your $24,500 contribution in a traditional 401(k). Your $8,000 catch-up, however, has to go into a Roth 401(k). What this means is that if your company doesn’t offer a Roth 401(k), you may not be able to make a catch-up contribution.
A change that isn’t all bad
At first, you may find this new 401(k) rule problematic, since it limits your options. But there’s actually a huge silver lining.
Higher earners often forgo Roth retirement plans because they’d rather contribute on a pre-tax basis. But the perks that come with a Roth 401(k) could benefit you greatly later in life.
For one thing, gains in a Roth 401(k) are tax-free, and withdrawals are tax-free as well. You might assume that you’ll be in a much lower tax bracket in retirement. But if you bring a lot of savings into retirement and maintain a higher income, that may not be the case. So getting access to some of your money tax-free could be very helpful.
Plus, Roth 401(k)s do not impose required minimum distributions. You might appreciate having a portion of your savings in an account you don’t eventually have to tap annually. And if any part of you wants to leave some of your retirement savings behind as an inheritance, then it’s especially important to have at least a portion of your nest egg in a Roth account.
It’s generally optimal to have complete control over how you save for retirement. Unfortunately, higher earners are now subject to different terms in the context of making 401(k) catch-ups. But rather than see the above change as a bad thing, consider the good it might do for your retirement.
