With the way the world is changing now, we all want to save as much as possible. However, if you are saving for retirement, it’s important to note that the rules are changing. For many years, workers could choose between putting money in a traditional retirement account where you get a tax break now and pay taxes later or a Roth account, where you pay taxes upfront but enjoy tax-free withdrawals in retirement.
However, a recent IRS rule denies wealthy incomes that option. Individuals who earn more than a specific amount will have to utilise Roth accounts for their catch-up contributions, which means they will have to pay taxes on the money now rather than waiting until retirement.
What’s Changing
On December 29, 2022, the SECURE 2.0 Act became a law. This act made provision for higher catch up contributions, later ages for required minimum distributions, the ability for employers to match contributions to Roth accounts, and automatic enrollment in retirement plans.
What are catch-up contributions? It’s basically contributions that workers who are 60 years and older, can contribute to their 401 (k) or similar retirement plans. The goal of this is to help people increase their savings as retirement approaches.
However, as per the new rule, any person who is earning more than $145,000 per year will no longer be able to make these catch-up contributions on a pre-tax basis. Instead, all of that money must go into a Roth account.
In simple terms, instead of decreasing your taxable income now, you will pay the tax. However, when you retire, your withdrawals will be tax free.
Why the Government Made This Move
The reasoning behind this is basic. Wealthier individuals pay taxes now and it allows the government to collect the money now rather than waiting until the funds are withdrawn.
Another point that lawmakers have made is that Roth accounts benefit people in the long run, this is because withdrawals are not taxed during retirement and individuals do not have to be concerned about paying taxes in the future.
Who Will Be Affected
This change doesn’t apply to everyone.
- Those income earners who earn above $145,000 must put catch up contributions into Roth accounts.
- Middle- and lower-income workers: Still get to choose between traditional pre-tax or Roth contributions.
- People age 60 and older
It is evident that this rule impacts a specific group of people.
What This Means for Your Pay check
This is something important to note. Since Roth contributions are taxed the same time, people may notice a change in their take-home-pay, ie. It might feel a little smaller than before.
People paying into the Roth system now, must not feel that this is bad news. Paying taxes now will allow to withdraw your retirement savings without paying tax then. It’s actually beneficial to you in the long run and even if taxes go up in the future, it won’t make a difference to you because you would have already paid your taxes.
How to Prepare
If you’re a high earner who will be affected, here are a few steps to consider:
- Make sure your contributions are being redirected properly into a Roth account.
- Try and adjust your budget accordingly, as you will be paying more taxes now.
- Keep in mind the long-term benefits of paying taxes now.
- Get advice from a financial advisor, on how to maximize your savings
The Bigger Picture
Even though this change might bring a mix of emotions and reactions, it is important to look at the bigger picture when you withdraw your savings.
It is important to note that the rules are constantly changing and adjustments need to be made in order to ensure financial stability in the future. The goal is a peaceful retirement and staying informed and making proactive decisions is extremely important.