IRS announces 401(k) limit increases to $20,500

The contribution limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan has been increased from $19,500 to $20,500 beginning with the 2022 calendar year.

Additionally, the income ranges for determining eligibility to make deductible contributions to traditional Individual Retirement Arrangements (IRAs), to contribute to Roth IRAs, and to claim the Saver’s Credit have also all increased for 2022.

Below are the updated phase-out ranges for IRA contributions in 2022:

Single Taxpayers

For single taxpayers covered by a workplace retirement plan (even if only for a portion of the year), the phase-out range is increased to $68,000 to $78,000, up from $66,000 to $76,000.

Married Filing Jointly Taxpayers

If the spouse making the IRA contribution is covered by a workplace retirement plan, the phase-out range is increased to $109,000 to $129,000, up from $105,000 to $125,000.

If the spouse making the IRA contributor is not covered by a workplace retirement plan but is married to someone who is covered, the phase-out range is increased to $204,000 to $214,000, up from $198,000 to $208,000.

Married Filing Separately Taxpayers

If a taxpayer is covered by a workplace retirement plan, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.

Roth IRAs

The income phase-out range for taxpayers making contributions to a Roth IRA is increased to $129,000 to $144,000 for single and head of household taxpayers, up from $125,000 to $140,000. For married couples filing jointly, the income phase-out range is increased to $204,000 to $214,000, up from $198,000 to $208,000. The phase-out range for a married individual filing a separate return who makes contributions to a Roth IRA is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.

Simple IRAs

The amount individuals can contribute to their SIMPLE retirement accounts is increased to $14,000, up from $13,500.

Key employee contribution limits that remain unchanged

The limit on annual contributions to an IRA (Roth or Traditional) remains unchanged at $6,000. The IRA catch-up contribution limit for individuals aged 50 and over is not subject to an annual cost-of-living adjustment and remains $1,000, for a maximum contribution amount of $7,000.

The catch-up contribution limit for employees aged 50 and over who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan remains unchanged at $6,500. Therefore, participants in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan who are 50 and older can contribute up to $27,000, starting in 2022. The catch-up contribution limit for employees aged 50 and over who participate in SIMPLE plans remains unchanged at $3,000.

Details on these and other retirement-related cost-of-living adjustments for 2022 are in Notice 2021-61, available on IRS.gov.

The Smartest Way to Minimize Tax on a ROTH IRA Conversion

Considering converting your Traditional IRA into a Roth IRA? You’re not alone. Many of my clients are wondering if they should convert their IRA now and pay tax on the conversion this year, or wait till next year when tax rates may be lower.

If you are already sold on converting to a Roth IRA, you can convert this year without worrying about changes to the tax code! If tax rates turn out to be lower next year under tax reform, you can use the recharacterize-and-reconvert strategy to shift the conversion’s tax consequences from 2017 to 2018.

What are the benefits of a ROTH conversion? Roth IRAs have two major advantages over traditional IRAs:

  1. While distributions from a traditional IRAs are taxed as ordinary income (except to the extent they represent nondeductible contributions), Roth IRA distributions are tax-free if they are “qualified distributions”
  2. While Traditional IRAs are subject to the lifetime required minimum distribution (RMD) rules that generally require minimum annual distributions in the year following the year in which the IRA owner attains age 70 1/2, Roth IRAs aren’t subject to the lifetime RMD rules that apply to traditional IRAs (as well as individual account qualified plans).

There are other tax advantages. Since distributions from Roth IRAs are tax-free (if they are qualified distributions), they could keep you from being taxed in a higher tax bracket. Not only that, Qualified Distributions from Roth IRAs don’t enter into the calculation of tax owed on Social Security payments, and they have no effect on Adjusted Gross Income (AGI) based deductions!

Keep in mind that converting from a Traditional IRA to a Roth IRA, (or from another pre-tax qualified plan to Roth IRA) is not income-tax-free. Instead, it is subject to tax as if it were distributed from the traditional IRA (or qualified plan) and not rolled over into another plan of the same type, but it generally isn’t subject to the 10% premature distribution tax. A substantial conversion could move a taxpayer into a higher bracket and/or result in reduced tax breaks that have AGI-based phaseouts or “floors”.

If you convert your pre-tax retirement account to a Roth IRA during 2017, you have the ability to determine when to pay tax on the conversion—in the year of the conversion, or in the following year. This unique opportunity allows you to minimize your tax liability on the conversion, should significant changes to the tax code occur.

Here’s how it works: If congress fails to pass a tax code overhaul, or if the reform fails to lower your 2018 marginal tax rate, and you are making a Roth IRA conversion this year, simply report the transaction on your 2017 return. But if tax reform succeeds, and your marginal tax rate will be lower next year (in 2018) than this year, you can shift the conversion’s income from 2017 to 2018 through a 2-step process.

Step 1 – recharacterization. The conversion from a traditional IRA to a Roth IRA can be recharacterized (reversed or cancelled out).

The recharacterization is made via a trustee-to-trustee transfer directly between financial institutions or within the same financial institution. Any recharacterized conversion (or Roth IRA rollover from a traditional IRA) will be treated as though the conversion or rollover had not occurred. Any recharacterized contribution will be treated as having been originally contributed to the second IRA, not the first IRA. The amount transferred must include related earnings or be reduced by any loss.

Ideally, a recharacterization should be made by the due date (plus extensions) of the taxpayer’s return for the affected year, and reflected on the return for that year.

However, you can make a recharacterization even after you have filed your return for the year for which a conversion to a Roth IRA was made. Technically, you have six months from the unextended due date of the return to make a recharacterization of the amount you previously converted to a Roth IRA. For example, a conversion from a traditional IRA to a Roth IRA in 2017 may be recharacterized as a contribution to a traditional IRA as late as Oct. 15, 2018. If you want to make a recharacterization after having filed the return for the affected year, you simply file an amended return reflecting the transfer, and write “Filed pursuant to section 301.9100-2” on the amended return.

Step 2 – reconversion. After you convert an amount from a traditional IRA to a Roth IRA, not only may you transfer that amount back to a traditional IRA in a recharacterization, but may later reconvert that amount from the traditional IRA to a Roth IRA. If you take these steps, your resulting income will be fixed at the time of the reconversion.

It’s important to keep in mind that a reconversion cannot be made before the later of:

  • The beginning of the tax year following the tax year in which the amount was converted to a Roth IRA; or
  • The end of the 30-day period beginning on the day on which the IRA owner transfers the amount from the Roth IRA back to a traditional IRA by way of a recharacterization.

This timing rule applies regardless of whether the recharacterization occurs during the tax year in which the amount was converted to a Roth IRA or the following tax year.

If you have questions on ROTH conversions, feel free to contact us for assistance!

What Is The True Cost Of An Early Withdrawal From Your 401(k)?

Tapping into your 401(k) as if it were a rainy day fund should always be a last resort. Many individuals are not aware of the negative tax implications of an early withdrawal from a retirement account. Before we go more in-depth, here are the key take-aways:

  • Borrowing or taking early withdrawals from your 401(k) can result in large tax burdens in addition to tax penalties
  • While exceptions exist, the most common withdrawals (education or buying a home) are still subject to tax penalties
  • If you borrow from a 401(k), loan funds will not grow in value and will automatically be converted to a withdrawal if you leave your employer, voluntarily or involuntary, while the loan is still outstanding.

401(k) Penalties

The penalties for early withdrawals from your 401(k) are assessed at a flat 10% rate on the total distribution. So, if you take a $50,000 distribution from your 401(k) before reaching 59 ½ years of age, you will owe a penalty of $5,000 before even paying any federal income tax on this amount. Remember, most 401(k) contributions are pre-tax deferrals, meaning you receive a deduction in the year you contribute, but you eventually pay tax on the withdrawals and earnings when you retire – hopefully in a lower tax bracket.

Exceptions to the Rules

There are exceptions to the 10% early withdrawal penalty mentioned above, but they are typically rare situations. Distributions made because of total and permanent disability and distributions made to cover medical expense that are deductible and exceed 10% of your adjusted gross income whether or not you itemize your deductions for the year. All exceptions can be found here.

401(k) Loans

Many employers and plan administrators offer the opportunity to borrow funds from your 401(k). Loans from your 401(k) can have some upside, such as low interest rates and not showing on your credit report, but there are also some downsides. Borrowed funds do not participate in the market or growth of your retirement account.

Quite possibly the biggest risk with loans is the immediate payback clause if you are laid off, quit, or are terminated as an employee. If you do not payback the full amount of the outstanding loan, the outstanding balance will be considered a distribution and no further repayment would be required. Not only does this subject you to the 10% early withdrawal penalty, but the withdrawal will be fully taxable at your marginal rate. Since this would be considered income, it can catapult you into a higher tax bracket, resulting in higher taxes on all your income.

Here’s a brief example of how this might look. Let’s say you are a married taxpayer with W-2 income of $150k. Based on 2017 estimated tax brackets, you would be in the 25% tax bracket. If you had a $50k loan from your 401(k) and were unexpectedly laid off, you would have to pay that loan back immediately. If you couldn’t afford to pay this loan back immediately, that $50k would become taxable in 2017, pushing you into the 28% bracket. The tax on that $50k distribution is now $14k PLUS the early withdrawal penalty of $5k, costing you a total of $19k. To summarize, a $50k early withdrawal would only leave you with $31,000!

Proposed Increases to the Social Security wage base

The Social Security Administration’s Office of the Chief Actuary (OCA) has projected an increase in the current Social Security wage base from $118,500 (2015 & 2016) to $126,000 for 2017.

This is bad news for those who are self-employed, operating as either a sole-proprietorship or a single-member LLC (SMLLC). Based on this estimate, each self-employed person with at least $126,000 in net self-employment earnings will pay $15,624 in Social Security taxes alone for 2017. This tax will be in addition to medicare taxes and income taxes at the taxpayer’s ordinary marginal rate.

Below are the social security wage base projections for 2017 on:

  • 2017 — $126,000
  • 2018 — $129,900
  • 2019 — $135,900
  • 2020 — $142,500
  • 2021 — $148,800
  • 2022 — $155,100
  • 2023 — $161,700
  • 2024 — $168,300
  • 2025 — $175,200

The OCA is projecting that the Social Security trust fund will become insolvent in 2034. As an entrepreneur, what steps are you taking towards minimizing your exposure to the Social Security Tax?