In a move that will no doubt cause great delight to all those who are looking to save up for their retirement, the IRS has announced that it will be increasing the 401(K) contribution limit from this month onwards. As a result, the 401(K) contribution limit has been increased from its previous limit of $22,500 to $23,000. Senior citizens over 50 years of age are further allowed to save an additional $7,500 as ‘catch-up contributions’, up to a total of $30,500. 401(K) plans are popular savings tools in the US as the contributions to the account are made before they are taxed by the federal government. These increases also apply to 403(b) plans, most of the 457 plans, and the federal government’s Thrift Savings Plan. The IRS has also announced it will be raising the IRA annual contribution limit up to $7,000 from $6,500 from next year onwards. Unlike the 401(K) accounts, these are not employer-sponsored and have lower limits, making them less popular, but still have the benefit of being tax-deferred. People aged 50 and older can opt to contribute an additional $1,000 to the new limit, until a total contribution of $7,500.
The increase is not a shocking one, of course, as the IRS makes such adjustments annually, based on a cost-of-living-based formula. The increases are only significant during times of high inflation, which has a higher impact on taxpayers. According to a Congressional Research Service report that analysed the available data on retirement contributions to defined contribution plans in 2021, only a very small fraction of people hit the maximum limit in their retirement contributions – about 8.5% of the total. The latest changes also mean that more Americans can qualify for Roth IRAs than before. Roth IRAs tax the contributions made to the fund upfront, which means that the fund’s investment earnings can grow free of tax, as long as the money is not withdrawn before the account holder is 59 ½ years old.
The changes don’t stop there – the new income phaseout range from the IRS has risen from $146,000 to $161,000 for individuals and heads of households. The previous range was $138,000 to $153,000. The range for married couples who file jointly will rise from $218,000 – 228,000 to $230,000 – 240,000. Despite these adjustments, however, professional services network PwC found that one in four Americans has no retirement savings. Their report found that US households with individuals between the ages of 25 and 64 have a significant deficit in their retirement savings. It is estimated that the difference between the savings they should have and actually do have amounts to about 3.68 trillion dollars. Meanwhile, research conducted by the Federal Reserve suggests that the median retirement account balance in the US was as low as $65,000.
In fact, there are a range of factors that have affected the US retirement system in recent years. These factors have effectively functioned to put increasingly intensifying pressures on the industry, leading to slowing revenue growth. These pressures have actually caused some retirement fund management firms to exit the industry. The US market as a whole is dependent on the dwindling contributions plan industry as an investor fund and it is estimated that more than 60% of the US’s retirement assets are held in these contribution plans. These numbers represent a shift in investment risk from the corporate sector towards the employees. There is a clear need therefore for broader benefits for the public to counteract the pressures that discourage them from saving for their retirement. These can include debt paydowns, supplemental income, and services such as managed advice. It is also possible to make use of the fact that retirement paths are now more diverse than they once were in the past: there are now people who opt to retire earlier in life, some plan to work reduced work hours, and others decide to keep exploring new endeavors.
Plan sponsors who are looking to increase plan participation therefore need to create new approaches of their own that cater to these diversifying needs and expectations. About half the workforce in the US, some 63 million individuals do not even have access to or participate in an employer-sponsored retirement program. While expanding the benefit offerings and adapting the product offerings are obvious answers to the issue, the industry needs to do more to broaden its own horizons in order to mitigate the inherent issues in the system. The retirement industry in America can do so by diversifying from simply seeking to help their clients plan and grow their wealth to also helping them plan for their retirement, which would create different types of demand and more opportunities for the industry. Some of these additional services can include emergency healthcare, elder healthcare, and even child healthcare. Providing these types of services will help make participating in contributing plans more attractive for the workforce while increasing demand for the industry again.
For now, one of the most attractive points about the IRS plans is the fact that the funds help participants shield their savings from being taxed. As described, this is because the portion of an individual’s income that is contributed to the 401(K) is tax deferred. This shields the contribution from tax in the year it is earned, and allows them to grow over the years they remain in investments. However, withdrawals made from the 401(K) post-retirements will be subject to the usual withdrawal taxes. A Roth 401(K) would of course only be subject to tax through the contributions made into it, while withdrawals remain tax-free. The rules surrounding retirement funds in the US can be more than a little confusing, and not everyone is even eligible for one or the other of these schemes.
(Theruni Liyanage)