Regular contribution limits for 401(k) plans remain untouched in the Senates version of the tax plan, but thats not the case for catch-up contributions for workers over 50 years old.
Typically, workers are allowed to contribute $18,000 this year, with savers over 50 permitted to put away an extra $6,000 in their accounts. The Senate filed an amendment, introduced by Utah Republican Senator Orrin Hatch, earlier this week increasing the catch-up contribution limits for 401(k), 403(b) and 457(b) retirement savings plans to $9,000 (to be added after maxing out contributions), but theres a catch: if the proposal is approved, that additional money must be added after-tax instead. According to the amendment, it would raise revenue for the country within 10 years.
See: Money Milestones: This is how your finances should look in your 50s
But what would it do for workers? It depends on their current and future tax brackets. Already, its difficult for many people to save for retirement, let alone max out their contribution limits. About 10% of Vanguard participants maxed out their 401(k) plans in 2016, according to an analysis by the Center for Retirement Research at Boston College, but keep in mind, Vanguard has a disproportionate number of large plans with higher earners, the researchers said. The contribution limit was also increased to $18,500 for 2018, the Internal Revenue Service announced earlier this year.
The amendment was a surprise to many, and not a good one for some. The Financial Planning Association, a member organization comprised of financial adviser professionals, most of which are Certified Financial Planners, said in a statement the proposal was disheartening. These critical plans make it possible for millions of Americans to save for their eventual transition out of the workforce and into retirement, it said. Eliminating the contributions on a pre-tax basis for those savers age 50 and older will greatly hinder their ability to save.
But not everyone thinks this is a worst-case scenario. For those who are able to afford the additional $9,000 (or up to $9,000), theyll likely save regardless what the rules say, said Daniel Lash, a financial adviser and partner at VLP Financial Advisers in Vienna, Va. The difference between a traditional and Roth account, whether its a 401(k) plan or an individual retirement account, is the way the money is taxed traditional accounts are invested with pre-tax dollars and therefore taxed at withdrawal, whereas a Roth account is funded with after-tax dollars and therefore comes out without being taxed. The money is always taxed at the current tax bracket that means at time of withdrawal, people are usually at a higher tax bracket than they were when they were first starting to save for retirement, Lash said. Since someone 50 or older is probably in the highest tax bracket theyll be in before retirement, the change wont affect them too much.
In fact, the change could be overall positive, said Taylor Hollis, a financial adviser at Equitable Trust Company in Nashville. Not only will it allow them to achieve tax-free growth, but it may introduce workers to this type of saving, she said. Also, if people have savings that are both funded by pre-tax and after-tax dollars, theyll be able to withdraw funds slowly from each account and manipulate how much theyre taxed while still attaining the amount they need any year in retirement, Lash added.
Also see: 7 ways to catch up if youre behind on retirement savings
Regardless, catch-up contributions can be a critical savings vehicle for employees. If a 50-year-old with $200,000 in a 401(k) plan took full advantage of the catch-up contribution for 15 years (as it is now, with pre-taxed dollars), that person would have an account with $1.07 million at 65, compared with someone with $925 million without the additional savings. By 70, that could be $1.58 million versus $1.35 million, according to financial services firm Northern Trust. The numbers would vary if it were a Roth, however, because the money would be growing after taxed at the employees current bracket.