Authors: Charles Crowley, CFP® AIF® and Eric Cramer, CFP®, CFA®
As we’ve written, the Roth IRA may be “The Holy Grail” of investing. Because of this, investors should pay attention to the asset location strategy of their investments for 401(k) plans in 2024. Maximizing the after-tax return through a smart asset “location” strategy can yield meaningfully positive results, which is why Roth IRAs play such a critical role.
Roth IRAs, if handled properly, never create an income tax liability on investment returns, so they can be the perfect vessel for the most tax-burdensome elements of a diversified portfolio.
Going back nearly two decades now, working investors with a company-sponsored retirement plan have found themselves with a new option to consider: the “Roth 401(k)”. This feature, a staple in most plans but not necessarily all, allows a worker to designate a percentage of their elected salary deferral to receive Roth treatment. Rewind a couple of years and the Secure 2.0 Act of 2022 stipulated that this special tax treatment is additionally available for employer matching and non-elective contributions into the plan as well.
So, what is a “Roth 401(k)”? What are the eligibility requirements for Roth 401(k)s? And what is the 2024 401(k) contribution limit? Let’s break it all down.
New 401k Contribution Limits for 2024
Creating a 401(k) in 2024 presents businesses and employees with a number of different routes. Over time, employees can forgo the current period tax deduction in order to increase their assets such as catch-up contributions in the tax-free category. Investment returns in a retirement plan accrue to various funding sources, such as pre-tax salary deferral, post-tax Roth 401(k) salary deferral, and pre-tax employer contributions. The investment earnings of the plan that are pro-rated to the Roth source get the identical tax-free status, and the compounding effect means that earnings on the earnings will never get taxed.
With 2024 401(k) rules allowing $23,000 in salary deferral plus $7,500 in annual catch-up contributions for those aged 50 and over by the end of the year, the importance of these choices can overshadow the importance of any choices made about contributions to an IRA (which has much lower 2024 401(k) contribution limits).
But there is yet another important 401(k) 2024 contribution limit that investors should become familiar with; it’s applied to defined contribution plans and is called the Section 415(c)(1)(A) limit. In 2024 the Section 415 limit rose to a whopping $69,000! Let’s take a moment to break that number down.
How in the world, you might ask, can someone get that much money into a 2024 401(k) plan and beyond? You might be lucky enough to have an employer who is making a contribution to your plan, but even if you contributed $23,000 and your employer matched you dollar for dollar (and let’s be real, that’s rare), then that’s still only $46,000 for your 2024 401(k).
Implications for Roth 401k Contributions
You may never have known that the tax code allows employees to make after-tax contributions to their employer-sponsored retirement plans over and above the normal salary deferral of $23,000. Your plan may not even allow it, but it should. The rules allow the employee to add money to their 2024 401(k) plan after tax (so no current period deduction is taken) until the total plan contribution equals the limit of $69,000. Factor in the additional catch-up contribution limit of $7,500, and you’ll find a grand total for older employees of $76,000!
In the past, this was probably not a good move. Remember that just like the Roth 401(k) contribution rules, the money being used for a post-tax contribution has already been taxed. But unlike the Roth contribution, which is also post-tax, the earnings do not retain the same tax status as the contribution. That means that your after-tax 2024 401(k) contribution will build up earnings that will eventually be taxed at your ordinary income tax rate when withdrawn. Annuities work like this, which is why they are often a bad tax move. If that money were simply invested in a taxable brokerage account, investments that grow in value could receive the preferential long-term capital gains tax treatment.
Changes in Catch-Up Contributions
There was an important change to Roth 401(k) eligibility in 2010. Plans can allow after-tax contributions to be converted to the Roth status as an “in-plan Roth conversion”. Since the money has already been taxed, converting to a Roth carries no tax bill if done immediately. In the simplified case where an employee maxes out their 2024 Roth 401(k) deferral and then makes this after-tax contribution up to the limits, they could add $69,000 plus the $7,500 in catch-up contributions to their Roth investments.
Real-world practicalities that limit this approach are worth mentioning though. First, your plan may still not allow Roth contributions. Even if it does, it may not allow after-tax contributions, and if it does then it still may not allow in-plan Roth conversions. All these plan features for a 401(k) in 2024 may add a bit to the cost of administering your plan or it may simply be that your plan administrator hasn’t paid for the latest software upgrade to accommodate this level of complexity.
Employer Matching Changes
You should also remember that your ability to make after-tax contributions is reduced by your employer contribution to keep the total at $69,000 plus the catch-up contribution of $7,500, although most people don’t complain about getting free money from their employer. There is also the more complicated issue of a mandatory discrimination test applied to retirement plans called the ACP (Average Contribution Percentage) test, which is designed to make sure higher salaried employees don’t get too good of a deal.
If this leaves you a bit confused, don’t feel like you are alone. Many employers feel burdened by having to explain these options to their employees and just go for the less complicated approach. But as word gets out among financial planners and HR professionals in corporate America, demand for these 2024 401(k) features will rise.
You can be part of a wave of investors requesting access to these benefits if you contact your benefits department and ask some simple questions:
- Does your 2024 401(k) retirement plan allow you to designate your salary deferral contributions to be Roth contributions (remember, these are made post-tax and don’t get a deduction, but grow tax-free)?
- Does your 2024 401(k) retirement plan allow you to further designate employer matching and non-elective contributions as Roth contributions?
- Does your 2024 401(k) retirement plan also allow you to make additional post-tax contributions over and above any Roth contributions and catch-up contributions? If so, to what limits (remember, this may be a bad deal unless you can also get a “yes” answer to the next question too)?
- Does your 2024 401(k) retirement plan also allow you to make in-plan Roth conversions of your post-tax contributions? If so, does this capability include employer contributions, and can you make a “streamlined election” that causes the contribution to be immediately converted or does it happen at year-end (which may have a tax bill on any earnings converted)?
When you get the answers to these questions, give us a call. Our team of experienced 401(k) advisors can walk you through the choices you should consider.
Impact on Retirement Planning
For those investors who earn enough money to increase their savings rate substantially and hit their 2024 401(k) contribution limits, the long-term financial value of growing their Roth assets is a big deal. Investors who are lucky enough to have a pension plan, or who are worried about the income tax obligations of being forced to take required minimum distributions from non-Roth retirement assets once they reach age 70 1/2, should consider this a form of tax diversification that gives them needed flexibility. Even the self-employed and business owners who are looking at plan design issues should think about what this could mean for themselves (and their employees) and ask us for help.
One last note: all of the 401(k) limits mentioned above are for 2024, and one of the great things about the structure of these limits in our tax code is that they are indexed for inflation. That means that the numbers will change over time and keep up with the cost of living. Always check to see what the current numbers are. If you have any additional questions, feel free to contact us to speak with an advisor today.
2024 401(k) FAQs
How much can I contribute to my 2024 Roth 401(k)?
The 2024 401(k) contribution limits allow for $23,000 in salary deferral and $7,500 in catch-up contributions.
What are the Roth IRA rules for 2024?
The maximum amount you can contribute in 2024 is $7,500 if you are aged 50 or under. This limit increases to $8,000 for those older than 50.
What is the new law for Roth 401(k) plans?
In 2022, the Secure 2.0 Act passed, allowing for special tax treatment on certain types of 2024 401(k) plans.
What is the solo 401(k) limit for 2024?
In 2024, investors can contribute up to $69,000 ($76,500 if you are over the age of 50).
This communication contains general investing information that is not suitable for everyone and is subject to change without notice. Past performance is no guarantee of future results and there is no guarantee that any views and opinions expressed will come to pass. The information contained herein should not be construed as personalized investment advice, tax advice, or financial planning advice, and should not be considered a solicitation to buy or sell any security. Investing in the stock market and the bond market involves gains and losses and may not be suitable for all investors. Indices are not available for direct investment.