Categories: Personal Finance

Saving for retirement just got more complicated

The Secure Act 2.0 legislation passed late last year added new retirement savings options but also had some potential takeaways for unsuspecting savers. Understanding these potential pitfalls may help you make better decisions, or at least prepare for the future.

In my last column, I covered one set of these changes: new exceptions to the 10% federal penalty for tapping retirement money early. For this column, I’ll cover what you need to know about the Secure 2.0 changes to catch-up contributions and company matches for workplace plans.

A POTENTIALLY PROBLEMATIC CATCH-UP PROVISION

Catch-up provisions have long allowed older workers to put more money into retirement plans. In 2023, for example, people age 50 and older can contribute an additional $7,500 to 401(k)s and 403(b)s, on top of the standard $22,500 deferral limit for all employees in those accounts. plan.

Contributions that go into the pre-tax option of the plan are deductible. But starting next year, people making $145,000 or more will no longer get a tax deduction for their catch-up contributions to workplace retirement plans. They are instead required to contribute money to the plan’s Roth option. (People earning less than $145,000 may have the option, but not the requirement, to put those contributions into a Roth.)

Withdrawals from Roths are tax-free in retirement, which can be a big benefit to many savers, says Colleen Carcone, director of wealth planning strategies at financial services firm TIAA. Contributing to a Roth is often recommended for younger workers who expect to be in the same or higher tax bracket in retirement.

But many people’s tax brackets drop once they retire. Roth contributions may make less sense for older workers who may pay a higher tax rate on their contributions than they would avoid on their withdrawals.

Many financial planners still recommend putting even a small amount of money into a Roth so retirees can better control their retirement tax bill, Carcone said.

However, the loss of the tax deduction may discourage people from making contributions, said economist Olivia S. Mitchell, executive director of the Pension Research Council, which researches retirement security issues.

And there’s another issue: Not all workplace plans have a Roth option. If an employer doesn’t add a Roth option, no one can make those contributions, Collado said.

ANOTHER PROBLEMATIC PROVISION: LAST-MINUTE CATCH-UPS

Starting in 2025, workers ages 60 to 63 will be able to make larger catch-up contributions to workplace retirement plans. The maximum is whichever is greater: $10,000 or 150% of the standard catch-up contribution limit. The $10,000 will be adjusted annually for inflation. At age 64, the lower catch-up contribution limit applies again.

Higher earners making these contributions should use the plan’s Roth option. Low incomes should be given the option to do so. (The $145,000 income limit is adjusted annually for inflation, so we don’t yet know what the exact cut-off amount will be when it takes effect.)

Higher limits may be helpful for those who can take advantage of them. However, many people’s incomes decline by the time they reach age 60 and they may not have more money to contribute. A 2018 analysis of data by ProPublica and the Urban Institute found that more than half of workers over the age of 50 with steady, full-time jobs were pushed out of jobs before they were ready. to retire – and most will never recover financially.

And certainly no one should put off saving for retirement thinking they’ll catch up later, warns certified public accountant and financial planner Marianela Collado, who serves on the American Institute of CPAs’ personal financial planning executive committee.

“Nothing beats the power of starting to save early in your career,” says Collado.

COMPANY MATCHES YOU MAY LIKE

Secure 2.0 continues the so-called “Rothification” of retirement plans by giving employers the option of placing matching funds in workers’ Roth accounts.

Currently, matching funds are contributed to pre-tax accounts, so they do not add to a worker’s taxable income. Matching funds contributed to a Roth account, in contrast, are considered taxable income for the employee.

It is not mandatory for anyone. Employers don’t have to offer this option, and employees don’t have to take it if it’s offered, Collado said. If you opt for Roth matching funds, however, you should be prepared to pay higher tax rates.

Again, paying taxes now may make sense if you expect to be in a higher tax bracket in retirement — and you’re willing to cough up the extra cash.

THE TAKEAWAYS

Roths have many advantages, and many people welcome the opportunity to save this way, but Roth contributions are not right for every saver. The Secure 2.0 changes have added enough complexity that people should consider getting expert advice about whether they’re saving enough and in the right ways, Carcone said.

“It’s just important for individuals to make sure they’re meeting and talking with their financial advisor,” Carcone said.

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This column was provided by The Associated Press to the personal finance website NerdWallet. The content is for educational and informational purposes and does not constitute investment advice. Liz Weston is a NerdWallet columnist, a certified financial planner and author of “Your Credit Score.” Email: lweston@nerdwallet.com. Twitter: @lizweston.