Why is the 401(k) Tax Break Going Away?

 Recently, the IRS (Internal Revenue Service - a revenue service for the US federal government, which collects taxes and implements the IRC [Internal Revenue Code]) passed a new policy. As of July 2023, individuals can only put a maximum of $22,500 into their 401(k) account. The 401(k) is a retirement plan to which you can make annual contributions (up to a limit). People above fifty can put an extra $7500 into their 401(k) accounts (a maximum of $30,000). These are called catch-up contributions. The IRS also states that individuals who earned more than $145,000 in the prior year must put extra money in their 401(k) accounts. Doing this helps generate income tax revenue for the government, as individuals must pay taxes every time they take money out of their 401(k) account.

According to the IRS's new policy, people over fifty put their money in a Roth 401(k) account instead of the traditional one. In the traditional 401(k) account, tax benefits are given to the individual upfront. When that individual withdraws money from their 401(k) account, they pay tax. The Roth 401(k) account reverses this process. When an individual puts money into their Roth 401(k) account, they don't receive any tax benefits upfront. Instead, they have the privilege of taking money out of their 401(k) account early on, but they also have to pay taxes. Fortunately, tax rates will only increase for people above fifty, who make catch-up contributions and earn at least $145,000 annually. 

Although removing the 401(k) tax break is beneficial for the US government (due to the extra income tax revenue they will earn), it is also beneficial for younger and older Americans. For younger people, putting a cap on how much money they can put in their 401(k) accounts will incentivize them to take money out of their 401(k) accounts later in the future (for example, at the age of seventy-three instead of sixty), and thus, not put them into a higher tax bracket. Thus, they will pay less in taxes when they eventually withdraw money from their 401(k) account. Requiring Americans over fifty who make catch-up contributions and earn more than $145,000 annually to put their money in a Roth 401(k) account will benefit their children and grandchildren. Their heirs will be able to inherit income tax-free money.

Even though this policy that the IRS passed may seem unfair initially, it is a good move. It will help younger individuals thrive when they get older and decide to withdraw money from their 401(k) accounts and help reduce tax rates for the kids and grandkids who inherit the property of their wealthy parents and grandparents.

Source:

YouTube, YouTube, 20 July 2023, https://www.youtube.com/watch?v=2ZRoVjYqrbU. Accessed 20 July 2023.