As we ring in the New Year, it is once again time to draft a list of New Year’s resolutions. Many of your resolutions may be focused on health, such as eating better, exercising, and losing weight. Other resolutions center on family or spending more time with loved ones. We should get after both of those in 2022; if two years of Covid showed us anything, it is that nothing matters more than your health and loved ones.
Next on the New Year’s resolution docket are getting your finances in order and saving more for your retirement. We are here to help you understand the funding of the different types of retirement plans available to you. This will assist as you juggle paying for your current responsibilities while at the same time saving for your retirement. The federal government offers tax incentives to help you save for your retirement years, which could be helpful for you if you understand them and use them to your maximum retirement savings benefit. This just may be one resolution you can stick with throughout the entire year.
We have put together a retirement account saving and spending roadmap for you. This tool can be of assistance whether you have just started your first job out of college or if you are in your late career counting down the days until a secure retirement. For those that are nearing or in retirement, we will share some insights on taking money out of your retirement accounts.
Employer Sponsored Retirement Plans
Company retirement plan contribution limits for 2022:
The maximum contribution is $20,500 or 100% of your compensation, whichever is less for company sponsored retirement plans such as a 401k or 403(b).
If you are age 50 and older, you get a “catch-up” contribution of $6,500 for a total of $27,000. If you want to contribute to the “catch-up” bucket, you may have to indicate an additional withholding, so be sure to check with your plan provider.
Company retirement plan distributions – RMDs:
Required minimum distributions (RMD) begin at age 72 if you have funds in an employer sponsored plan.
If you are still working for the company, you may be able to get an exception and delay the RMD until you have separated from service. The plan must allow this, and you must be employed for the entire year.
Types of Employer Sponsored Plans
You may be offered a 401k plan through your employer if they are a for-profit company. If they offer a company match, this is the first place you will want to allocate retirement savings dollars. For example, your company’s plan may match up to 3 percent of your salary or 50 cents up to 8 percent of your salary. The company match is free money that you can put toward your retirement saving. If you don’t participate, then you miss out on the match; who would want to turn away free money?
Another advantage is that contributions are made on a pre-tax basis lowering your taxable income for the year. The money is usually invested in a mix of mutual funds and exchange-traded funds, while some plans allow individual equities. The Bedell Frazier Financial Planning team can help you or your children with their 401k asset allocation.
- Accumulation Key: If you want to contribute to the 50 and over “catch-up” bucket, you may have to indicate an additional withholding. Be sure to check with your 401k provider.
- In Retirement Key: If your plan allows, you may be able to access these savings at age 59.5 penalty-free if you are focused on early retirement. The growth of the investments over time are tax-deferred which is a fantastic wealth accumulation tool. However, a 401(k) is subject to required minimum distributions (RMD) which is when you have to start taking withdrawals every year. The current age in which required minimum distributions begin is 72 and the withdrawals are taxed as ordinary income. There can be some tremendous financial planning opportunities in the years between the time you retire and no longer receive paycheck income and begin the mandatory ordinary income generated by your required minimum distributions.
Your contributions are after-tax dollars rather than pre-tax dollars, but when you make withdrawals in retirement, they are tax-free. The Roth 401(k) offers the combination of tax-free growth and tax-free withdrawals in retirement.
- Accumulation Key: If you contribute to your employer’s Roth 401(k), you are still eligible to receive the company match, if they offer one. Due to federal regulations, it will be deposited into your traditional 401(k).
- In Retirement Key: While the Roth 401k is subject to required minimum distributions (RMD), the withdrawals are tax-free. This sets up some tax diversification in your retirement withdrawals, just as you diversify your investment portfolio, you should also consider diversifying your tax liability. Many investors have a disproportionate amount of their wealth tied up in tax-deferred accounts such as traditional IRAs and 401(k).
Similar to a 401(K), a 403(b) is a taxed advantaged retirement plan for non-profit organizations and some public-sector workers like teachers. The investment options are limited to mutual funds and annuities, with most plans not allowing individual equities, exchange traded funds (ETF) or Real Estate Investment Trusts (REITs).
- Accumulation Key: An extra perk of a 403(b) plan is that if you have worked for the same eligible organization for at least 15 years you are allowed to make a bonus contribution of $3,000 per year with a total lifetime of $15,000. This is in addition to your age 50 and over “catch-up” contribution of $6,500, meaning you could hypothetically contribute $30,000 for five years.
- In Retirement Key: If you are a retired public safety office (police officer, fire firefighter, ambulance crew member), you can withdraw up to $3,000 from your 403(b) plan and use it to pay for accident, health, or long-term care insurance.
This is a tax-advantaged retirement plan primarily for state and local government employees, like municipal employees and civil servants. In addition, some charities have 457 plans for their employees.
- Accumulation Key: A unique feature of 457(b) plans is that in the three years before retirement, you are allowed to contribute up to double the annual limit or 100% of your salary, whichever is less.
Individual Retirement Savings Accounts
IRA contribution limits for 2022
- The maximum contribution is $6,000 or 100% of your earned income, whichever is less.
- If you are age 50 and older, you can add a “catch-up” contribution of $1,000.
- Note that a non-working individual can use their spouse’s earned income to contribute to an IRA.
IRA Required Minimum Distributions for 2022
When you reach age 72, required minimum distributions(RMDs) begin for Traditional IRAs. Roth IRAs do not have RMDs.
Types of Individual Retirement Savings Accounts
There are several tax incentives associated with Traditional Individual Retirement Accounts (IRA). If you don’t have a retirement plan through your employer like a 401(k), the contributions you make to a traditional IRA are usually tax-deductible.
- Accumulation Key: Even if you don’t qualify for a tax-deductible IRA contribution you can still make an after-tax contribution to a traditional IRA. If you leave your current job, you can roll your 401(k) over into a Rollover IRA.
- In Retirement Key: When you reach the age 72, required minimum distributions begin on a traditional IRA with the distributions taxed as ordinary income, except any after-tax contributions which are not taxed. The penalty is big if you miss your RMD, 50% of the amount not withdrawn. It is imperative to understand the rules surrounding drawing down your retirement accounts. Even if you don’t need the RMD for living expenses make sure the funds are withdrawn and reinvested in a non-retirement account. Another option is to gift the money to charity directly from the IRA by using a Qualified Charitable Donation (QCD), no taxes are due on distributions made via a QCD.
You could choose to make your annual IRA contribution to a Roth IRA. One of the more attractive retirement accounts available because the money grows inside the account tax-free and there are no taxes on withdrawals. There are also no required minimum distributions with a Roth IRA. There are income thresholds that limit who may contribute directly to a Roth IRA. For 2022, to contribute the maximum your adjusted gross income must be less than $129,00 if single or $204,000 if married filing jointly.
- Accumulation Key: There are other ways to get money into a Roth IRA if you are above the income contribution limits:
- Contribute and Convert: If you do not have a Traditional IRA account, you may be able to utilize a strategy called a back door Roth where you contribute after-tax dollars to a Traditional IRA (no tax deduction) and then convert those tax-free into a Roth IRA. The Build Back Better legislation passed in the House of Representatives last fall would eliminate the back door Roth as part of its tax reforms. We will continue to monitor the events as the Senate is scheduled to take back up the legislation in the New Year along with updates from our Washington insiders.
- Roth Conversion: Another way to get dollars into a Roth account is by doing a Roth Conversion. You take a distribution from your current IRA or 401(k) and roll it into a Roth account. You pay taxes on that distribution in the current tax year while creating a Roth tax-free bucket for the remainder of your life (under current tax law). The conversion is not limited to the $6,000 – you can convert as much as makes sense based on your other taxable income and time horizon. A great time to execute this strategy is when you are in that “income valley” between having paycheck income and taking the required minimum distributions from your retirement accounts. We can model this in our financial planning software for you if you are interested in learning more.
- In Retirement Key: There are no taxes on withdraws, so the Roth IRA is a great emergency fund bucket in retirement. If you need to pay for a major expense, you won’t also have the associated tax bill from the tax-deferred account such as in IRA or 401(k). Another key advantage of a Roth IRA is that there are no required minimum distributions (RMD). That means you can keep the money growing tax-free for your entire life. This is what makes Roth IRAs a popular choice for families looking to preserve generational wealth. The account can grow tax-free, and the owner can pass it on to the next generation with no income tax burden to the recipient. With the passage of the SECURE Act the Roth IRA passed on to a child can grow tax-free another ten years before any withdrawals need to be taken.
Self-Employed Retirement Plans
The type of account that works best for each person depends on several factors, including their net income, their age, and if they have employees or a spouse working in the business. The Bedell Frazier Financial Planning Department and your tax professional can provide additional information.
Types of Self-Employed Retirement Plans
Small business owners can open a SIMPLE (Savings Incentive Match Plan for Employees) IRA if they don’t have another retirement plan in place. Under a SIMPLE IRA, contributions made can be deducted by the business and all employees’ contributions are immediately vested.
- Accumulation Key: The employee contribution limits for 2022 are $14,000 a year to a SIMPLE IRA with a 50 or older catch-up contribution of $3,000. Employers must make contributions for each of their employees, either dollar for dollar matching contributions equal up to 3% of their employee’s salary, or a non-elective contribution of 2% of employee’s salary, whether or not they contribute to the SIMPLE IRA.
- In Retirement Key: Like many other retirement accounts, withdrawals made before reaching age 59.5 may be subject to a 10% penalty in addition to any ordinary income taxes. That penalty rises to 25% if you take the money out within two years of first contribution to the SIMPLE IRA.
Another option for business owners is a Simplified Employee Pension or SEP IRA. The main advantage of the SEP IRA, is the much higher contribution limit than a regular IRA account, up to $61,000 in 2022.
- Accumulation Key: Only employers can make contributions to a SEP IRA. If the business owner is contributing to their own SEP IRA, they must contribute the same percentage to all your employees’ SEP IRAs. For 2022, the employer may contribute up to 25% of an employee’s compensation or $61,000, whichever is less.
- In Retirement Key: SEP IRAs are subject to required minimum distributions and those distributions are taxed as ordinary income.
A good choice for those who are self-employed with no other employees, except maybe a spouse who works part-time. As with other 401(k) accounts, you can have a traditional Solo 401(k) or a Roth Solo 401(k).
- Accumulation Key: A great feature of a Solo 401(k) is the ability to make contributions to the account as both employer and employee. You get the standard $20,500 with the $6,500 catch-up as an employee and as the employer contribute 25% of your compensation. In 2022, the total contributions cannot exceed $61,000, or $67,500 if you are 50 and above.
There are many factors that contribute to selecting the proper retirement account to fund during your working years. This year, make a resolution around your financial security, a resolution that will serve you well! There are many routes to a secure retirement, we can assist and guide you wherever you are along your road to retirement.