With the end of 2021 and the beginning of 2022, there is still time to take advantage of 2021 contributions and establish your 2022 ones. After all, who will if you do not look out for your finances and especially your retirement? The answer to a degree maybe firstly, you, Social Security, and finally your employer may help some, but it is all up to you. That is why it is so important that you know and understand what you can and cannot do regarding retirement accounts both at work and on your own. So, where do you begin, you may be wondering.
401k Plans
First, there is a two-approach way to look at this if you work for someone. If they offer an employer-sponsored 401k plan with a company match, that is where you need to start. I say this because, with an employer match, you have an instant return on your contributions that you do not want to pass up. In plakin terms, that match is free money, and you never pass up free money when saving for your retirement. For example, I work for the federal government, and our equivalent is the Thrift Savings Plan or TSP. The government will match 1-3% at 100% and 4-5% at 50%. What this means is if you defer or contribute 5% of your salary, the federal government will match it with an additional 4%, allowing you to save 9% of your salary, with it costing you only 5%. Free money!
Now how much can you contribute to your 401k? For 2022 those under the age of 50 can contribute up to $20,500, and if you are over 50, you are allowed an extra “catch-up” contribution of $6,500 for a total of $27,000. On a side note on the contributions you make to your 401k plans, there are two types, Traditional and ROTH.
With a Traditional 401k contribution, you will reduce your 2022 tax liability by the amount you contribute on a pre-match basis. So, as in our example of contributing 5%, you will reduce your taxable income by 5%. Then when you make your withdrawals at age 59 ½, you will pay ordinary income tax on the money you contributed plus all of the gains it has accumulated over your career. Without providing individual tax advice, a Traditional 401k is most beneficial for higher-income earners as their income tax in retirement, in theory, should be lower.
Then there is a ROTH 401k with the same contribution limits, but unlike a ROITH IRA, there are no income limitations on having a ROTH 401k. This particular type of 401k will have the best advantages to you early in your career when your tax brackets tend to be lower. The advantage comes in as these contributions are made on a pre-tax basis, meaning you pay taxes on these contributions in the year you made them, so they do not reduce your tax liability like a Traditional 401k. But the withdrawals are 100% tax-free after the age of 59 ½.
For information on the limits for 2022, you may get more information at https://bit.ly/3zlucfs.
Individual Retirement Accounts or IRA
Much like the workplace 401k, retirement accounts also come in two types: Traditional and ROTH. But unlike the 401k, the contribution limits are much lower at $6,000 annually for those under 50 and with the additional catch-up contribution of $7,000 for those over 50. But here, there are income limitations and restrictions on the type you may make them too.
With the Traditional IRA, you make contributions that will reduce your taxable income, just like the 401k. But unlike the 401k, you may only make these deductible contributions if you also have a workplace retirement plan. For single earners, contributions are tax-deductible if your modified income is less than $68,000 and $109,000 for married filing jointly. Contributions for a ROTH IRA are different, allowing a single person who makes less than $125,000 to make contributions and $198,000 for married couples. But as of this post, if you make more than these amounts and want to contribute to a ROTH, there is a “backdoor” method that currently allows you to do this. Contact me directly or another fee-only Registered Financial Consultant for more information or assistance with this.
These amounts just discussed are for the 2021 earning and tax year. And if you have not made or have an IRA account, it is not too late to open and fund one as you have until the tax deadline to do this, generally April 15th of each year. And the best part is you may also fund your 2022 IRA at the same time, provided you will have at least as much earned income as you contribute for both years. The contribution limits will not change for 2022, but I am sure the IRS will adjust the income limits. For more information on IRA’s visit https://bit.ly/3qGI7IT.
SEP-IRA
Finally, if you own your own company or are a 1099 contractor, you have the SEP-IRA available to you to fund your retirement. The SEP-IRA will generally be funded after the close of the current tax year due to how the contributions are calculated. Why is that? Well, for the 2021 tax year, your contributions are limited to the lesser of 25% of your compensation or $58,000. And to plan for 2022, it will be the lesser of 25% or $61,000.
Now the reason you will want to consider a SEP-IRA is two-fold. It provides you with a means of saving a substantial amount of money for your retirement. And two, it will reduce your tax liability by the amount you contributed—a real win-win. For more information on SEP-IRA’s visit https://bit.ly/31kHZWY.
Social Security
Now I know I mentioned Social Security. But as that is not an option or something within your control, we will leave that discussion for another time and place. But I am confident that the Social Security benefits will be in place for years to come. In what form I cannot and will not even begin to speculate on, but it will survive.
If you have any questions or need any additional information, please contact me directly if you are in or near Nashville, Tennessee, or anywhere in the US. If you prefer someone closer, seek out a qualified fee-only Registered Financial Consultant who is also a fiduciary.
