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The 'Roth-ification' of retirement savings

Among the many changes contained in the act, the catch-up contribution change stands out because it fundamentally alters the tax advantages pursued by those older workers who use catch-ups to make up for lost time.

Let’s consider the potential downsides of the catch-up change.

Reduced tax savings for high earners

Higher-earning Americans have long benefitted from the significant upfront tax break offered by traditional 401(k)s. The shift to Roth accounts removes that benefit for catch-up funds, likely raising that earner’s near-term tax liability.

Affected take-home pay

In traditional 401(k) accounts, the contributor’s tax bracket is calculated after the contribution. That means paychecks would naturally shrink for higher, older earners who maintain their catch-up contributions through this change. These folks will be stung by paycheck amounts that drop by the exact amount they contribute to the Roth.

So how can this change work in your favor?

Retiring in the same tax bracket

People often choose a traditional 401(k) account over a Roth account because they believe their tax bracket will be lower in retirement. But high earners who have accumulated large 401(k) and traditional IRA balances may find themselves in the same — or even higher — tax bracket when required minimum distributions, or the minimum that must be withdrawn from retirement accounts each year, begin at age 73. In this case, the Roth’s tax-free growth proves attractive.

Taxes now, rewards later

While higher taxes on upfront contributions work against higher earners at first, tax-free growth and withdrawals in retirement will go a long way toward recovering what was lost.

Withdrawing contributions without penalty

Even the savviest savers can find themselves in a jam. Unlike a traditional 401(k), you can withdraw Roth contributions at any age, for any reason, without taxes or penalties, though financial experts advise against it. However, withdrawing Roth earnings before age 59.5 and before the Roth account has been open for five years will trigger a penalty.

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Late change

The retirement account catch-up contribution changes as outlined in the SECURE 2.0 Act were originally meant to take effect in 2024. However, a large number of companies expressed concern about the amount of time needed to implement the changes, and on Aug. 25 the IRS announced a two-year transition period with respect to the changes.

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About the Author

Chris Clark

Chris Clark

Freelance Contributor

Chris Clark is freelance contributor with MoneyWise, based in Kansas City, Mo. He has written for numerous publications and spent 18 years as a reporter and editor with The Associated Press.

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