Millions of High-Earning Americans Are Losing Popular 401(K) Tax Deductions — Here’s What It Means for YOU

Changes to a popular 401(K) tax deduction will affect millions of high-earning Americans starting next year.

Employees over age 50 are entitled to catch-up contributions to their 401(K)s worth up to $7,500 this year. The annual limit on all contributions is $30,000.

But as of 2024, those earning more than $145,000 will no longer be able to put those catch-up payments into a traditional 401(K).

Instead, the money will only be funneled into a Roth IRA account, under new rules passed by Congress in December.

The main difference between a Roth account and a 401(K) pot is that the former is pre-taxed – but can be withdrawn for free when you retire.

With a 401(K), employees are not taxed on their contributions until they withdraw them.

This option is often preferred because retirees are usually in a lower tax bracket at retirement, meaning they pay lower taxes – although this varies depending on income.

For example, if an employee fell into a 35 percent tax bracket, he would have to pay $2,625 for a $7,500 catch-up payment.

But if they fell into a 22 percent bracket at retirement, the levy would also drop to $1,650.

Experts say the change will have a major impact on US retirement planning. Figures from financial planning firm Vanguard show that 16 percent of eligible employees paid catch-up contributions last year.

However, many argue that it can be a good thing, as employees often ignore the value of Roth accounts.

So says Brooklyn financial advisor Cristina Guglielmetti Wall Street Journal“The Roth is such a powerful savings tool that I try to put at least a few dollars in that bucket for all my clients, regardless of tax bracket.”

The changes don’t apply to IRAs that have a $1,000 catch-up contribution limit this year for those over 50. The limit on all contributions is $1,500.

Roth pension pots are considered relatively controversial, with their value often underestimated.

Many prefer the traditional 401(K) route because they assume they will fall into a lower tax bracket upon retirement.

But this isn’t always the case — especially since taxes are likely to rise by the time an employee reaches retirement age.

Investment adviser Patrick Donnelly recently told the Dailymail.com: “If you are contributing for your retirement, you should consider what your taxable income is now and what it will be when you retire, but what he needs to consider are the prospects for future tax rates.

“We are in a relatively favorable tax environment today for both high and low income earners, compared to historical income tax rates.”

Donnelly projects that this means the US is looking forward to an extended period of substantially higher average tax rates in the future – which he says could reach peaks of 15 or 17 percent.

Experts have repeatedly sounded the alarm about America’s retirement crisis, with each generation failing to put enough money into their 401(K)s.

A recent survey from the National Institute on Retirement Security found that the average “Generation Z” household — those between the ages of 43 and 58 — had only $40,000 saved for retirement.

This is despite the oldest members of the cohort being less than two years away from being able to withdraw money from their 401(K)s, aged 59 and a half.

And they’re four years away from being able to claim Social Security at age 62. Right now, that means the cohort would only have $1,600 a year to see them from 60 to 85.

Separate data from Northwestern Mutual shows that the average American is currently saving just seven percent of their 401(K) goal.