Secure 2.0 changes in catch-up contributions and corporate matching of work plans can trip naive savers.
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The Safe Act 2.0 bill, passed late last year, added new retirement savings options, but also harbored some potential pitfalls for unsuspecting savers. Understanding these possible pitfalls can help you make better decisions, or at least prepare you for what’s to come.
In my last column, I covered one of the changes: a new exception to the 10% federal fine for early retirement. In this column, we’ll cover what you need to know about Secure 2.0’s changes to catch-up contributions and corporate matching of workplace plans.
Potentially problematic catch-up clause
Catch-up provisions have long allowed older workers to put more money into retirement plans. For example, in 2023, people over the age of 50 will be able to contribute $7,500 to their 401(k) and 403(b), in addition to the standard $22,500 deferment limit for all employees on those plans.
Contributions included in the pre-tax option of the plan are tax deductible. But starting next year, people earning more than $145,000 a year will no longer receive tax credits for contributions to their workplace retirement plans. Instead, it will be required to donate funds to the plan’s loss option. (People earning less than her $145,000 have the option, but not required, to put in a catch-up contribution to Roth.)
Colleen Kirkorn, director of wealth planning strategy at financial services firm TIAA, said withdrawals from Roth’s could be a big boon for many savers because they’re tax-free in retirement. Contributions to Roth are often recommended for young workers who are expected to have the same or higher tax rate after retirement.
But many people pay less in taxes when they retire. Roth’s contributions make less sense to older workers who may be paying a higher tax rate on their contributions than they avoid when withdrawing.
Carcone said many financial planners still recommend that retirees invest at least some of their money in Roth to better manage their retirement taxes.
But the loss of tax credits could discourage people from making back-up contributions, says economist Olivia S. Mitchell, executive director of the Pension Research Council, which studies retirement security issues.
And then there’s another problem. Not all workplace plans have Roth options. Corrado says if employers don’t add loss options, no one will be able to cover it.
See also: Do I have to roll a Roth 401(k) into a Roth IRA? What are the rules?
Another problematic clause: last-minute catch-up
From 2025, workers aged 60 to 63 will be able to make larger additional contributions to their workplace retirement plans. The maximum is $10,000 or 150% of the standard catch-up contribution limit, whichever is greater. $10,000 is adjusted annually for inflation. Once you turn 64, the lower catch-up contribution limits apply again.
High-income earners making these catch-up contributions must use the plan’s Roth option. Low-income people must be given the option to do so. (The $145,000 income limit adjusts annually for inflation, so we don’t yet know the exact cutoff amount when this will take effect.)
Read more: Some retirement contributions are about to be taxed — these organizations want to slow it down
A higher limit could be useful for those who can take advantage of it. However, many people have declining incomes by the time they reach their 60s and may not have extra cash to contribute. A 2018 data analysis by ProPublica and the Urban Institute found that more than half of workers in their 50s with stable full-time employment were kicked out of their jobs shortly before retirement, and the majority never recovered financially.
And certainly no one should put off retirement savings thinking they can pay it back later, warns Marianela Corrado, a CPA and financial planner who serves on the Executive Committee for Personal Financial Planning at the American Institute of Certified Public Accountants.
“Nothing can replace the ability to start saving early in your career,” says Corrado.
Read more: What you need to know about Secure 2.0 right now
Business matching can be expensive
Secure 2.0 continues the so-called “Rothification” of retirement plans by giving employers the option of depositing matching funds into their employees’ Roth accounts.
Matching funds are currently donated to a pre-tax account and therefore do not add to the worker’s taxable income. In contrast, matching funds donated to the Roth account are considered taxable income of the employee.
This is not mandatory for anyone. Employers are not required to offer this option, Corrado said, and employees are not required to accept it when offered. However, if you choose a Roth matching fund, be prepared to pay higher taxes.
Again, if you expect to pay a lot in taxes when you retire, and you’re prepared to spit out the extra money, it makes sense to start paying taxes now.
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While Roth has many benefits and many people welcome the opportunity to save in this way, Roth donations are not suitable for all savers. Carcone said people should consider getting expert advice on whether they’re saving enough in the right way because of the added complexity of Secure 2.0’s changes. “The only thing that matters to individuals is making sure they meet and talk to their financial advisor,” said Carcone.
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Liz Weston of CFP(R) writes for NerdWallet. Email: firstname.lastname@example.org. Twitter: @lizweston.
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