Next Level Planning
What is the maximum 401(k) contribution?What is the maximum 401(k) contribution? Everything you should know to help your employees save smarter this year. Every year, the IRS updates the rules governing 401(k) and IRA contributions, and they recently announced the guidelines for 2022. So what are the updates for 2022? Here’s the big news: The contribution limit for employer-sponsored 401(k) plans is $20,500 for individuals under age 50, up from $19,500. This is the first time the limit has gone up in two years! Now, let’s get into the details. In this article, we’ll discuss the new 2022 limits and rules—and how they may impact your retirement goals. What you need to know about retirement plans (and their contribution rules) As you may know, there are two primary retirement plans: employer-sponsored retirement plans and IRAs. Here’s how they differ: Employer-sponsored plans—like 401(k), 403(b), and 457 plans—are only available if the employer offers one. If they’re eligible, individuals can contribute to both an employer-sponsored plan and an IRA. IRAs are tax-deferred or tax-advantaged retirement accounts that individuals (who qualify) can open up on their own—regardless of their employment situation. Because the IRS offers tax advantages to people who participate in these plans, there are naturally a few strings attached. Specifically, individuals can only contribute a certain amount of money in a given year—and that amount decreases if they earn above a certain threshold. Good news—Most people can contribute more in 2022. If your employees ask “what is the 401(k) limit for 2022?” you’ll be able to share the good news that most people can contribute up to $20,500 in 2022. This is up from $19,500, which was the limit in 2020 and 2021. When you look at the following contribution limits, you’ll notice that some of them take into consideration taxable income, which impacts how much highly compensated employees and low-income earners can save. Estimating taxable income can be complicated, and since Betterment is not a tax advisor, we suggest talking with a qualified tax professional. Let’s take a closer look at the 2022 contribution limits. 1. Employer-sponsored Plan Contribution Limits In 2022, the limit on annual contributions to Roth or Traditional 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plans increases to $20,500. The additional catch-up contribution limit remains unchanged at $6,500 for a total contribution limit of $27,000 for employees 50 years old and older. 2. IRA Contribution Limits In 2022, the limit on annual contributions to an IRA is unchanged at $6,000. The additional catch-up contribution limit for individuals 50 years old and over remains at $1,000. The total contribution limit is $7,000 for employees 50 years old and older. Retirement Account Contribution Limits Contribution Limits Catch-up Contribution Limit (for individuals age 50 and above) Account Type 2021 2022 2021 2022 Traditional IRA Roth IRA $6,000 $6,000 $1,000 $1,000 401(k) 403(b) 457 Plans $19,500 $20,500 $6,500 $6,500 Income Limits for Deductible Traditional IRA Contributions One of the best benefits of a Traditional IRA is that you can deduct contributions on your tax return. However, if you or your spouse are covered by an employer-sponsored retirement plan, Traditional IRA contributions are only deductible if your modified adjusted gross income (MAGI) falls below a certain threshold. Above that threshold, there’s a “phase-out” range in which an individual is eligible for a partial deduction, and after that range, contributions are not deductible. Traditional IRA Deductibility Limits for Individuals with an Employer-sponsored Plan 2021 2022 Filing Status Income (MAGI) Income (MAGI) Deduction Limit Single individuals ≤ $66,000 ≤ $68,000 Full deduction up to the contribution limit $66,000 – $76,000 $68,000 – $78,000 Partial deduction ≥ $76,000 ≥ $78,000 No deduction Married, filing jointly ≤ $105,000 ≤ $109,000 Full deduction up to the contribution limit $105,000 – $125,000 $109,000 – $129,000 Partial deduction ≥ $125,000 ≥ $129,000 No deduction Married, filing separately < $10,000 < $10,000 Partial deduction ≥ $10,000 ≥ $10,000 No deduction Traditional IRA Deductibility Limits for Individuals without an Employer-sponsored Plan 2021 2022 Filing Status Income (MAGI) Income (MAGI) Deduction Limit Single individuals All incomes All incomes Full deduction up to the contribution limit Married, filing jointly + neither individual or spouse has an employer-sponsored plan All incomes All incomes Full deduction up to the contribution limit Married, filing jointly + spouse has an employer-sponsored plan ≤ $198,000 ≤ $204,000 Full deduction up to the contribution limit $198,000 – $208,000 $204,000 – $214,000 Partial deduction ≥ $208,000 ≥ $214,000 No deduction Married, filing separately < $10,000 < $10,000 Partial deduction ≥ $10,000 ≥ $10,000 No deduction 3. Income Limits for Roth IRA Contributions To read more about the IRA deduction limits, refer to details available from the IRS. Roth IRA contributions are not tax deductible. However, qualifying withdrawals (typically in retirement) can be made on a tax-free basis. However, to make the maximum $6,000 Roth IRA contribution, an individual’s income must fall below a certain threshold. In 2022, eligibility to contribute to a Roth IRA starts to phase out at $129,000 for single filers and $204,000 for married couples (filing jointly). That’s a higher start of the phase out threshold than in 2021, which began at $125,000 for single individuals and $198,000 for married couples. 4. Income Ranges for Partial Roth IRA Eligibility Individuals whose incomes fall within the following ranges are limited to making partial Roth IRA contributions. Those whose incomes fall below these ranges can contribute the full amount. Individuals with incomes above the range cannot contribute to a Roth IRA that year. Income Tax Filing Status 2021 MAGI 2022 MAGI Single $125,000 – $140,000 $129,000 – $144,000 Married Filing Jointly $198,000 – $208,000 $204,000 – $214,000 If you are married and file separately and lived with your spouse at any point during the year, you will be completely phased out of making Roth IRA contributions if your MAGI is $10,000 or more. For more information and guidance regarding Roth IRAs, review the expanded IRS rules. Income Limits for the Retirement Savings Contributions Credit (Saver’s Credit) To help low-income people save for retirement, the IRS offers the “Saver’s Credit.” Individuals may be eligible for the credit if they’re saving for retirement and their income falls below specific ranges. This credit offsets the individual’s income-tax liability; however, it phases out as the individual’s adjusted gross income (AGI) increases.
Traditional and Roth 401(k)sTraditional and Roth 401(k)s Not sure what the difference is between traditional and Roth contributions for your 401(k)? We’ll explain. Ever hear the terms traditional 401(k) and Roth 401(k) thrown around and wonder – what are they? Should I be using them? Are these the keys to untold levels of wealth and financial security?! Easy does it. There are no secret weapons or silver bullets for securing a financially fit future. That said, traditional 401(k)s and Roth 401(k)s can be important tools when building your retirement strategy, so let’s make sure you know what they are. And a fun fact to know right away: you can use both. What do they have in common? A traditional 401(k) and Roth 401(k) are tax-advantaged accounts that allow you to save and invest for retirement (the tax advantages given to these types of accounts are not available in many other investing accounts). They’re available to you as a workplace benefit offered by your employer, and they’re funded with contributions from your paycheck – you set the amount, either as a dollar or a percent. The idea behind both is that they make it easier to save and invest for retirement automatically, like a built-in part of your budget. So what’s the difference? The difference is in how they are tax-advantaged. Traditional 401(k) contributions are made with pre-tax dollars, while Roth 401(k) contributions are made with after-tax dollars. Here’s an example. Let’s say you earn $40,000 a year and make contributions into a traditional 401(k). The contributions go into the account before your paycheck is taxed (“pre-tax”), lowering your taxable income. So if you save $3,000 throughout the year, you’d be paying taxes on $37,000 rather than $40,000. In addition, the money that you contribute—and any earnings—grow tax deferred until you withdraw it in retirement. At that time, your withdrawals are considered ordinary income and you’ll pay federal and possibly state taxes depending upon where you live. And, if you want to withdraw money before you turn age 59 ½, you’ll also be subject to a 10% penalty unless you qualify for an exception. If you decide to contribute to a Roth 401(k), the money is deducted from your paycheck after taxes have been taken out. So your paycheck is taxed now, reflecting your full salary of $40,000, which includes the contributions into the Roth 401(k) account. Roth 401(k) tax benefits come into play when you withdraw the money at retirement. Because you already paid taxes, you can withdraw contributions—and any earnings—tax-free if you’re age 59 ½ or older and have held your Roth 401(k) account for at least five years. Short answer: Traditional 401(k)s can lower your taxes now, but you’ll likely pay taxes when you withdraw the money at retirement. Roth 401(k)s don’t save you on taxes today, but you likely won’t have to pay taxes when you withdraw the money at retirement. Which type of account should I use? It ultimately depends on your unique financial situation and retirement goals. Betterment is not a tax advisor, and we encourage you to consult one if you want help reviewing your finances and goals. As a general rule: If you expect to be in a lower tax bracket in retirement, consider contributing pre-tax dollars into a traditional 401(k) account now, and you’ll pay taxes later. If you expect to be in a higher tax bracket in retirement, consider contributing after-tax dollars into a Roth 401(k) account, and pay your taxes now. What if I’m not sure if my tax bracket will be higher or lower in the future? You’re definitely not alone! In which case, it may make sense to invest in both. You’re allowed to make contributions to both types of accounts, spreading your tax exposure around. 5% in a traditional 401(k) and 5% in a Roth 401(k) would give you a 10% total contribution rate (in line with what many experts recommend). What if I want to withdraw my money early—that is, before I turn age 59 ½? Let’s start with the Roth 401(k). Because you already paid taxes on your contributions, you can generally withdraw that portion of the money tax-free. The portion of the withdrawal that represents your contributions to the account will generally be not taxed (and not subject to the 10% penalty). The portion of the withdrawal that represents earnings will be taxable and potentially subject to the 10% penalty. Most early withdrawals from a traditional 401(k) are taxed as ordinary income plus a 10% penalty. There are some exceptions, such as permanent disability. The tax advantages and ramifications of retirement accounts can be complicated. As Betterment is not a tax advisor, we encourage you to consult one to help you make this important decision. One more fun fact - former U.S. Senator from Delaware, William Roth, is the father of after-tax retirement accounts. Enjoy sharing that little bit of trivia at your next cocktail party, on us.