If you’re 50 or older, there’s one benefit to taking this step that you may be overlooking: the tax breaks for you. Now you can contribute more to your Roth or traditional Individual Retirement Account (IRA), employer-sponsored plan, or Health Savings Account (HSA) than you could when you were younger. You can even exclude more income from your tax calculations.
Congress included some of these provisions in the Economic Growth and Tax Relief Reconciliation Act, which took effect in 2002, over concerns that the baby boomer generation had not saved enough for retirement. Congress included other tax-saving provisions, such as a larger standard deduction, in the Tax Cut and Jobs Act of 2017.
If you’re behind on your retirement savings, tax law gives you a chance to catch up. And if you’re retired, or close to retirement, the tax code allows you to pay a little less tax. It’s a combination you shouldn’t pass up.
Contribute more to your retirement fund
For 2022, the contribution limit for employees who participate in 401(k), 403(b), most of the 457 retirement savings plans and the federal government’s Thrift Savings Plan has been increased to $20,500, up from $19,500 in 2021. Employees 50 and older can add an additional $6,500, for a total of $27,000.
The contribution limit for a traditional or Roth IRA is unchanged, at $6,000. The catch-up is $1,000, the same as in 2021. It is $3,000 for an Employee Savings Incentive Plan (SIMPLE).
However, many people miss this opportunity. Despite generous catch-up provisions for those 55 and older, only 15% of eligible people make it, according to the Vanguard Group’s “How America Saves 2021” report.
Meanwhile, data from the National Retirement Risk Index (NRRI) compiled by the Boston College Center for Retirement Research indicates that half of all US households will not be able to afford their current standard of living once their paychecks are regular. arrested. In June 2020, 50% of married retirees relied on Social Security payments for half of their income; for single people, this number was 70%. For 2022, the average Social Security retirement benefit is estimated to be just $1,657 per month.
These pension contributions can reduce your tax bill
In addition to making your retirement more comfortable, contributing to a tax-deferred retirement plan, like an IRA or 401(k), also lowers your income, which, in turn, lowers your income taxes. Thanks to this tax reduction, the increase in your contribution will not eat away at your salary as much as you think. If you earn $75,000 a year, for example, a 5% contribution to your 401(k) would put $144 in your account, assuming a 25% tax rate. But your bi-weekly salary will only drop by $108, according to Fidelity Investments.
Contributions to a traditional IRA are tax deductible as long as you follow IRS rules, including income limits. IRA contributions are fully deductible if you (and your spouse) are not covered by a workplace pension plan. However, the deduction may be limited if you are (or your spouse is) covered by a company pension plan and your income exceeds certain limits. For 2022, IRA deductions for single people covered by a workplace retirement plan are not allowed after the modified adjusted gross income (MAGI) reaches $78,000; the deduction disappears for married couples filing jointly when MAGI reaches $109,000.
Retirement contributions made to a Roth IRA or Roth 401(k) are made on an after-tax basis: you receive no upfront tax relief for these contributions, but withdrawals made from Roths in retirement are exempt of tax. Pre-tax money from traditional IRAs and 401(k)s grows tax-free, but you’ll end up paying taxes when you start making withdrawals in retirement.
Since saving an extra $6,500 on a 401(k) can be tough for some, Nicole Gopoian Wirick, Certified Financial Planner (CFP) at Prosperity Wealth Strategies in Birmingham, Michigan, advises her clients to evenly spread the amount of catch-up on each salary and automatically deducted. “Contributing $250 over 26 pay periods may seem more accessible,” she says.
Clark Randall, CFP at Financial Enlightenment in Dallas, Texas, encourages his clients to rethink their budget to increase their regular retirement contributions throughout the year. “The budgeting for this expense is the same as for any other. It takes discipline and compromise.
If you still want to make catch-up contributions to a Traditional IRA or a Roth IRA for 2021, you have time. The deadline is April 15, the date you file your tax return, unless you request an extension. However, 401(k)s, 403(b)s, Thrift Savings Plans, and most 457 plans operate by calendar year, so you’ll be investing for 2022 and have until the end of the year to do so.
You can wait until 72 to start your RMDs
Speaking of which, there’s also good news about required minimum distributions (RMDs), the minimum amount you need to withdraw from a tax-deferred retirement plan, like a traditional IRA. (Roth IRAs do not require distributions as long as the owner is alive.)
Under rules that came into effect in 2020, you can wait until the year you turn 72 before you have to start taking RMDs. Previously the age was 70 1/2. If you don’t need the RMD, consider donating it to charity. If you donate your RMD to a qualified charity directly from your retirement account, up to $100,000, you will not owe tax on the distribution.
