A Popular 401(k) Tax Break Is Going Away
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What is the main topic discussed in this episode?
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Here's your money briefing for Thursday, July 20th. I'm J.R. Whalen for The Wall Street Journal. The rules are about to change for retirement savers who make so-called catch-up contributions to their 401k accounts.
What is changing about catch-up contributions to 401(k) plans?
What the new rule says is that if you are 50 and older and making catch-up contributions and you earn more than $145,000 in the prior year, then your catch-up contribution has to go into a Roth 401k. It can't go into a traditional 401k.
We'll talk to WSJ retirement reporter Ann Tergesen after the break.
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Who will be affected by the new rule that forces catch-ups into Roth 401(k)s?
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Millions of high-earning Americans who make so-called catch-up contributions to their 401k accounts are in line to lose a popular tax deduction next year. WSJ retirement reporter Anne Tergesen joins us. So first of all, Anne, what is a catch-up contribution and what does it allow 401k account holders to do?
So a catch-up contribution is an extra contribution that people 50 and older are allowed to make to their 401ks.
How much can people over 50 contribute with catch-up contributions today?
So the way it works is this year, the IRS has set a limit of $22,500 that anybody can contribute to a 401k. And for an employee, that's the maximum that you can contribute. But if you're 50 or older, you can actually contribute an extra $7,500. So somebody who's 50 or older can put in a total of $30,000 this year into their 401k, thanks to these catch-up contributions.
So how are the rules changing, and do they affect more than just people in their 50s?
No, the change in the rules affects people 50 and older who are making catch-up contributions to their 401k.
How does a Roth 401(k) differ from a traditional 401(k) for taxes?
What the new rule says is that if you are 50 and older and making catch-up contributions and you earn more than $145,000 in the prior year, then your catch-up contribution has to go into a Roth 401k. It can't go into a traditional 401k.
All right, let's just stop for a moment and do a little 401k 101. What is a Roth 401k and how does it differ from a traditional 401k?
Okay, so the way that the Roth 401k and the traditional 401k differ is all about tax treatment of your contributions and tax treatment of the money that you withdraw in retirement. For example, with a traditional 401k, you get a tax benefit up front. The money that you put in is not taxed. in this current year that you contribute it. Instead, with a traditional 401 , when you take the money out in retirement, you pay income tax then. A Roth 401 kind of reverses that, and the money that you put into a Roth 401 is taxed in the current year when you contribute it. But in retirement, the money can come out tax-free.
So why are these rules being changed?
Why did Congress change the catch-up contribution rules and who pays more tax now?
So the reason why people who are making catch-up contributions, that's people who are 50 and older, who have incomes that are above $145,000, they are being kind of forced into putting those catch-ups into a Roth is because that generates income tax revenue right now. And Congress needed a way to pay for a retirement bill that passed last December, and that was one of the primary ways that they used to pay for it.
Will everyone pay more in taxes on their contributions under the new rules?
No. The only people who are going to be paying more in taxes than they would have otherwise are people who are 50 and older and are making catch-up contributions and earn more than $145,000 a year. Those people, if they had preferred or would have opted or been defaulted into a traditional 401k for those catch-ups, they would have gotten an upfront tax benefit that they will no longer get. And instead, the money will be taxed this year.
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Chapters
8 chapters
1
What is the main topic discussed in this episode?
0:01–0:43
2
What is changing about catch-up contributions to 401(k) plans?
0:43–1:39
3
Who will be affected by the new rule that forces catch-ups into Roth 401(k)s?
1:39–2:18
4
How much can people over 50 contribute with catch-up contributions today?
2:18–2:59
5
How does a Roth 401(k) differ from a traditional 401(k) for taxes?
2:59–4:14
6
Why did Congress change the catch-up contribution rules and who pays more tax now?
4:14–6:40
7
Why do financial planners recommend tax diversification with Roth accounts?
6:40–7:38
8
How do Roth accounts affect estate planning and inheritances?
7:38–8:33
Speakers
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