How to Maximize the IRS’s New Contribution Limits in 2022

The year has changed, and along with it, contribution limits to many tax-advantaged accounts. Each year the Treasury Department reviews the contribution limits in light of inflation data. As we all have read about or experienced as consumers, 2021 was a big year for inflation. Therefore, contribution limits for many tax-advantaged accounts have increased for the year 2022, meaning participants can contribute more to their employer-sponsored accounts.

Up Your 401(k) & 403(b) Contributions by $1000

The new regular contribution limit for 401(k)s and 403(b)s in 2022 is $20,500 (up from $19,500 in 2021). Those over 50 years of age can contribute another $6,500 per year, for a total contribution of $27,000.

As a refresher, there are three tax types of contributions associated with 401(k)s and 403(b)s:

Pre-tax contributions: Dollars contributed to 401k or 403b accounts are pre-tax, meaning the participant gets a tax deduction in the year of the contribution. While a tax deduction occurs in the current year, any money that is distributed post 59.5 is fully taxable when distributed. This type of contribution is valuable for those who are likely in a higher tax bracket while working than in retirement. Note that any distribution before age 59.5 will be taxed and is typically assessed a 10% early distribution penalty.

Roth-contributions: Many plans today offer a Roth contribution, whereby there is no tax deduction in the year of the contribution. Instead, the money is contributed after-tax and grows tax-free. Unlike pre-tax contributions, funds that are distributed from a Roth account after age 59.5 are completely tax-free. The earnings portion on distributions prior to 59.5 are taxed at ordinary income rates and assessed a 10% early distribution penalty. Those who are likely in the lowest tax bracket they will ever be in are good candidates for the Roth option.

After-tax or Post-tax contributions: Believe it or not, for some there is a way to contribute more than $20,500 (or $27,000 for those 50+) if the plan allows for after-tax contributions. Understanding the differences between after-tax IRA contribution limits and after-tax 401k contribution limits can be reached in Section 415 of the Internal Revenue Code. Section 415 states the maximum total contribution from the employee and the employer for 2022 is $61,000 (or $67,500 for those 50+). If the plan allows for after-tax contributions, employees are able to contribute the regular maximum, plus additional amounts on an after-tax basis, so long as the employee and employer contributions do not total more than $61,000.

It’s tempting to assume that after-tax contributions are the same as Roth contributions, but they are different. In the case of after-tax contributions, the growth on your contribution would be taxable when distributed, while the principal would remain tax-free.

Maxing out too early: You may be a 401(k) participant that would like to max out your 401(k) early in the year just to get it over with. However, in all likelihood your employer matches your contribution to some degree. Depending on how the match is calculated, you could end up leaving some money on the table if you max out too early. For example, let’s say your salary is $100,000 and your employer matches 50% of your contribution up to 6% of salary. That’s a potential employer match of $3,000. If you decided to max out over the first 6 months, you would get the $1,500 match for those 6 months. Your contributions would cease since you are at the maximum, but your employer match would also cease, shorting yourself $1,500. To avoid this, it’s best to even out your contributions over the course of the year.

457(b) Contribution Limits in 2022

Similar to 403(b)s, 457(b) retirement plans are sometimes offered by public-sector and nonprofit organizations. The 457(b) max contribution limit for 2022 is the same as the 403(b), that is $20,500 plus the catch up of $6,500 for those over 50. Moreover, if a participant is eligible for both a 403(b) and 457(b), the participant can contribute to both plans, up to their respective maximums. That’s right, a participant that falls in this category could potentially double their retirement savings by contributing $20,500 to each plan, for a total of $41,000.

Additionally, unlike 403(b)s you can take distributions from 457(b)s after termination and at any age, without triggering the 10% tax penalty.

SIMPLE IRA Contribution Limits in 2022

SIMPLE IRA plans are commonly offered to employees of small businesses with 100 employees or fewer. The functionality is very similar to a 401(k); however, the contribution limits allowed by IRS are not as generous. The regular contribution limit for SIMPLE IRAs in 2022 is $14,000 (up from $13,500 in 2021), while those ages 50 or older may contribute an additional $3,000.

Traditional IRAs vs Roth IRA

The contributions limits for Traditional and Roth IRAs in 2022 remain at $6,000, no change from 2021. Likewise, those over 50 years of age can contribute another $1,000 for a total contribution of $7,000.

To be eligible for Traditional or Roth contributions you must have earned income. However, keep in mind that income limits could preclude individuals from making contributions.

Roth IRA Income Limits: For 2022, the Adjusted Gross Income (AGI) phaseout for single filers begins at $129,000 and phases out completely at $144,000. For Married filers, the phase out begins at $204,000 and phases out completely at $214,000.

Traditional IRA Income Limits: Anyone can contribute to a Traditional IRA as long as they have earned income. However, whether the contribution is deductible or non-deductible depends on your AGI and if you or your spouse is covered by a workplace retirement plan (such as a 401(k) or 403(b)):

• Your contribution is always deductible if you are not covered by an employer-sponsored retirement plan.
• For single filers, the 2022 AGI phaseout for IRA contribution deductibility starts at $68,000 and completely phases out at $78,000.
• For married filers, if a workplace plan covers the spouse who makes the IRA contribution, the 2022 AGI phaseout begins at $109,000 and fully phases out at $129,000.
• For married filers where a workplace plan does not cover the spouse who makes the contribution, the 2022 AGI phaseout begins at $204,000 and completely phases out at $214,000.

Once again, distributing from Traditional and Roth IRAs prior to age 59.5 will trigger taxes and a 10% early distribution penalty. However, Roth IRA owners can always access their contributions (or basis) tax and penalty free. Only the earnings are taxed and penalized.

Health Savings Account Limits in 2022

If you are participating in a high-deductible health plan (HDHP) you may also contribute to a Health Savings Account. The HSA contribution limits in 2022 for individual coverage is $3,650 (up from $3,600 in 2021) while the limit for family coverage is $7,300 (up from $7,200 in 2021). HSA account holders who are age 55 and beyond make a catch-up contribution of another $1,000.

HSAs are unique because the contribution is tax-deducible in the year of contribution and distributions are tax-free if used for qualifying health care expenses. This gives participants the best of both worlds with the combination of tax-deductibility and tax-free growth. However, using the HSA for anything other than healthcare expenses before age 65 will trigger taxes and penalties (20%). After age 65, non-qualifying medical distributions from the HSA are essentially treated like an IRA distribution (subject to taxes with no penalties).

Maximizing Your Flexible Spending Account

A Flexible Spending Account (FSA) is an employer-sponsored savings account where employees can contribute pre-tax money to pay for out-of-pocket health and medical expenses. There are three types of FSA accounts: Healthcare FSAs, Limited Purpose FSAs, and Dependent Care FSAs. The max FSA contribution limits are detailed below.

Healthcare FSA: The 2022 IRS contribution limit for the healthcare FSA is $2,850, an increase of $100. However, employers may limit this contribution even further. Employees may use this money to pay for qualified medical expenses for themselves, their spouse, and their dependents. Talk to your CERTIFIED FINANCIAL PLANNER^TM practitioner about how your HSA can earn you triple tax advantages.

Limited Purpose FSA: A Limited Purpose FSA is similar to a Healthcare FSA, however they are more restrictive as they can only be used for vision and dental expenses. The 2022 contribution limit for this account type is once again $2,850.

Dependent Care FSA: Dependent Care FSAs are used the help parents pay for caregiving expenses while they are working. These expenses could include babysitters, daycare, preschool, etc. The 2022 contribution limit for this type of FSA is $5,000 for a couple filing a joint return or $2,500 for couples filing separately.

Health Savings Account vs. Flexible Spending Account: Does the FSA sounds a lot like the HSA? There are significant differences, primarily related to flexibility. In the case of the HSA, the individual controls how the account is managed and can roll the account over to another institution as their employer changes. FSAs are not as flexible as the employer technically owns the contributions. Depending on the employer, unused contributions to an FSA may be forfeited if not spent by the end of the year or shortly after. Also note that employees cannot participate in a Healthcare FSA and an HSA at the same time.

Should you contribute the maximum to your tax-advantaged accounts?

The answer to this question is not straightforward and depends on your individual situation. Of course, it’s always a good idea to contribute the minimum amount to a 401(k) or 403(b) to achieve the maximum employer match. However, one of the key things to remember when contributing to certain accounts such as 401(k)s, 403(b)s, or IRAs, is that you cannot access them prior to age 59.5 without incurring extra taxes and penalties (outside of a few exceptions). Therefore, when considering expenses that will occur before retirement, like a down payment on a home, weddings, or college education for children, it may be wise to diversify some of your savings to a non-qualified brokerage account or possibly an education savings account.

This is where the “tax bucket” strategy comes in. For example, one tax bucket is tax-deferred money, another is tax-free, and a third is a non-qualified brokerage account. How much of your portfolio should be in a tax-free bucket vs a tax-deferred bucket? Diversifying your savings among these different buckets will provide flexibility when cashflow needs arise both before and after retirement. A CERTIFIED FINANCIAL PLANNER^TM practitioner can help you think through how to best allocate your savings to ensure smooth sailing in the near-term and beyond.

Author: Wyatt Sten, CFP® | Associate Financial Advisor | Allegheny Financial Group

Allegheny Financial Group is a Registered Investment Advisor. Securities offered through Allegheny Investments, LTD, a registered broker/dealer. Member FINRA/SIPC.