Reviewing Updates to the 401(k) in 2024
As John F. Kennedy said, “Change is the law of life. And those who look only to the past or present are certain to miss the future.” Kennedy wasn’t specifically talking about financial planning when he said this, but he might as well have been. Much like death and taxes are the two things that you can’t avoid, life and legislation are certain to keep your financial plan in a constant state of change.
Recent legislative changes have impacted the 401(k), altering a crucial aspect of many individuals’ financial plans. These changes have been made to help make saving for retirement more accessible. Following these changes is always of primary importance to us. We do this so you don’t have to do it. This is one way we try to provide you with peace of mind on your investment journey. Due to the number of people impacted by the changes, it’s prudent to share these updates with you. At TCI, we believe that informed clients have better investment experiences.
Before we dive into the changes, it can be helpful to have a better understanding of how the 401(k) came to be such an important part of your financial journey in the first place.
Why is the 401(k) Crucial for Your Financial Journey?
The 401(k) retirement savings plan is a product of a provision in the Revenue Act of 1978. It established a new section of the Internal Revenue Code, section 401(k), which allows workers to defer a part of their salaries into a retirement savings account on a pre-tax basis. By reducing their current tax bill, this incentivizes employees to save for retirement and reduces the burden on employers to fund traditional pension plans. The concept became popular in the early 1980s when companies started to adopt 401(k) plans as an alternative to the defined benefit pension plan.
The 401(k) plan is now the primary savings vehicle for retirement in the United States. The key to its popularity is that it allows for meaningful employee savings and encourages employers to participate by contributing to employee accounts with matching contribution, up to a certain amount. Without the 401(k) plan, many Americans simply would not save for retirement. This legislation has played a significant role in the health and longevity of our financial system, as well as the physical well-being of older adults.
Notable Changes to the 401(k) Landscape in 2024
Several legislative changes and updates have been made to the 401(k) structure over time, aimed at improving regulations, expanding eligibility, and enhancing the overall effectiveness of these retirement savings accounts. The Secure Act 2.0 enacted at the end of 2022 introduced a number of changes to the retirement account landscape. It is worth noting some that are specific to 401(k) accounts.
Increased contribution limits:
The 2024 annual contribution limit is $23,000, with an additional $7,500 catch-up contribution for anyone 50 years old and older. So, people 50 and older can contribute $30,500 in 2024.
Additional penalty-free withdrawals:
Withdrawing from your 401(k) before turning age 59.5 comes with a 10% early-withdrawal penalty. There is a number of exemptions, including but not limited to, hardship withdrawals, first time home buyer, and education. New exceptions include up to $1,000 per year for a personal or family financial emergency. You’ll want to be extra careful here and be sure to know that you are in compliance with the rule.
Matching contribution for student loan repayment:
Employers are now allowed to make matching 401(k) contributions to employees who are making payments toward their student loans. Prior to this new rule, employees had to make their own contributions to the 401(k) in order to receive the matching contribution from their employer. This is a great opportunity for workers to avoid having to choose between paying off debt now and saving for later.
Roth requirement for catch-up contributions:
Catch-Up contributions must be made to Roth for any participants earning over $145,000 beginning in the 2026 tax year. (This was originally scheduled to begin in 2024 but was pushed back to 2026.)
Roth assets in the 401(k) will no longer be subject to the Required Minimum Distribution (RMD):
This alleviates a noted discrepancy between 401(k) and IRA accounts. Previously, Roth IRA’s have not been subjected to the annual RMD rule, while Roth 401(k) assets have been.
Automatic Enrollment:
Employers must now automatically enroll new employees into the 401(k) plan with a 3% contribution election. This makes employee participation automatic, and will certainly help to increase access to those who may be faced with barriers to entry.
Advantages of Utilizing the 401(k)
There are a number of key benefits to the 401(k) plan, including tax advantages for workers at all levels of the pay scale. Employer matching increases one’s ability to save more for retirement, automatic payroll deductions make it easy for employees to stay disciplined, and flexible investment options that give employees the ability to invest in a way that is appropriate for their individual needs.
One of the primary advantages is the ability to save to pre-tax or Roth, so participants can choose when to pay the taxes based on their current and projected future earnings. For example, younger people who are just starting their careers and are likely to be in a lower tax bracket may benefit from contributing to the Roth side of the plan. They will pay income taxes on those contributions now, but all the growth and future withdrawals will be tax-free for life. On the other hand, those who are in their peak earning years may decide to contribute to the 401(k) now with pre-tax dollars, effectively lowering their current tax rate. When they retire, they will have reduced income and will thus be in a lower tax bracket, so they would benefit from paying taxes later on the 401(k) withdrawals. The best part of all is that you can switch your contributions from Roth to pre-tax at any point. You have the flexibility to adjust your contributions with your circumstances.
The Limitations of the 401(k)
It’s important to keep in mind that while 401(k) accounts offer several advantages, they also have limitations. Primary among these is liquidity for those who have not yet turned age 59.5. Since the 401(k) is specifically designed for retirement savings, accessing the funds early can result in early withdrawal penalties. Any savings that go into the 401(k) need to be committed to the future. There are certain exceptions to this rule, but they need to be carefully considered and should often be taken only as a last resort.
Another disadvantage of 401(k)s is that plans have limits as to the amount that you can contribute each year. While most people do not have the ability to max out this contribution limit, it can be a limiting factor. Finally, for the most part, 401(k) plans offer limited investment options. Most plans have access to a few low-cost index funds but also, there are more expensive, actively managed funds that can have a negative long-term impact on your returns. With your Advisor’s guidance, be sure to pay attention to and understand your options. Together, you should carefully consider your financial goals and circumstances when deciding how much to contribute to a 401(k) and how to allocate their investments within the account.
The 401(k) is a key piece of the retirement puzzle that should not be ignored. At the end of the day, these new changes to 401(k) accounts are beneficial and therefore, it is a good thing that they are now in effect. However, there is no small amount of added complexity. The rule book has more pages, and the font is a smaller size. The new rules covered here do not exhaust the list of changes, and the brief descriptions provided are by no means necessarily complete. This blog covers only the important highlights. The point here is the same one that Kennedy made, “Change is the law of life.” We are paying attention for you, so that we can be flexible and ready to act, because no plan is set in stone. There are certainly more changes to come.
