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The IRS announced two major changes to retirement plans in 2022. First, the 2022 contribution limit for 401(k), 403(b) and 457 retirement accounts will increase to $20,500. That's up from the $19,500 limit in 2021 and 2020. Second, the IRS boosted tax deduction thresholds for traditional IRAs and Roth IRA contributions, so what your income qualifies you for may have changed. Will this impact what you save in the new year?
"This 401(k) and IRA change probably won't impact 90% of people," says Jamie Hargrove, a Louisville, Kentucky-based estate and trust tax attorney. Only those who have maxed out their 401(k) contributions in previous years should be affected, as well as those who were reaching the maximum allowed income for IRA deductions or contributions.
While the 401(k) contribution cap and IRA income phase-out increases won't affect everyone, others may see a change. Here's what you need to know.
Why Did the IRS Increase the 401(k) Contribution Limit?
The IRS sets a limit on yearly deductions and contributions to qualified retirement plans, such as 401(k)s, 403(b)s, 457s and IRAs, to prevent highly paid workers from benefiting disproportionately from these savings accounts. The caps are adjusted annually to account for inflation.
At 5.4%, the annual U.S. inflation rate in 2021 is higher than usual, according to the Consumer Price Index. This resulted in a higher-than-normal increase in maximum 401(k) contribution amounts. Whereas in 2021 and 2020, the maximum contribution was $19,500, the 2022 maximum contribution jumped $1,000 to $20,500.
Workers aged 50 and older can make a catch-up contribution to their 401(k), 403(b), 457 or thrift savings plan. The annual catch-up contribution remains unchanged in 2022 at $6,500, for a yearly maximum of $27,000.
How Did The IRS Announcement Change IRA Income Phase-Outs?
Besides the increased contribution limit for 401(k), 401(b), 457 and thrift savings plans, the IRS changed some key income phase-out ranges for traditional IRA tax deductions and Roth IRA contributions.
Changes to Traditional IRA Phase-Outs
A traditional individual retirement account, or IRA, allows you to stash away pretax funds for retirement. Deferring these taxes until the funds are withdrawn (hopefully for your retirement) helps you save money long term because you likely will have a lower taxable income in retirement and therefore will be taxed at a lower rate.
The amount that you can contribute to a traditional IRA in 2022 hasn't changed—it's still capped at $6,000. For those 50 and up who contribute to an IRA, the catch-up contribution also remains the same at $1,000.
Phase-out ranges, however, have increased in 2022 to keep up with inflation. Phase-out ranges determine whether an earner is eligible to claim a full deduction of their IRA contribution amount, a partial deduction or no deduction based on their income.
Traditional IRA income phase-out ranges for 2022 deductions are as follows:
- Single taxpayers covered by workplace retirement plan: The new phase-out range is $68,000 to $78,000. The 2021 range was $66,000 to $76,000.
- Married couples filing jointly, where one spouse is covered: If the spouse making the IRA contributions is also covered by a workplace retirement plan, the new phase-out range is $109,000 to $129,000. For a spouse making an IRA contribution who isn't covered by an workplace plan, the range is $204,000 to $214,000. These ranges are up from $105,000 to $125,000 and $198,000 to $208,000 in 2021, respectively.
- Married individual, covered by a workplace plan and filing separately: The phase-out range hasn't changed and remains $0 to $10,000.
Changes to Roth IRA Phase-Outs
While you can't deduct contributions to a Roth IRA on your taxes, the IRS still applies phase-out ranges to contribution amounts based on income. Roth phase-out ranges determine how much you're eligible to contribute, with some earners only eligible to contribute a reduced amount, and the highest-income earners ineligible to contribute at all.
Roth IRA contribution phase-out income ranges have also increased in 2022:
- Singles and heads of household: The income phase-out range is increased to $129,000 to $144,000. That's up from $125,000 to $140,000 in 2021.
- Married couples filing jointly: The income phase-out range is increased to $204,000 to $214,000. That's up from $198,000 to $208,000 in 2021.
- Married individual filing separately: The income phase-out range remains the same at $0 to $10,000.
Saver's Credit Contribution Limit Has Increased
The saver's credit incentivizes workers with low- and moderate-incomes to save for retirement with a tax credit of 50%, 20% or 10% of their contribution, depending on their income.
The income limit for the Saver's Credit has increased to $68,000 for married couples filing jointly (up from $66,000 in 2021), $51,000 for heads of household (up from $49,500 in 2021) and $34,000 for single people or married people filing separately (up from $33,000 in 2021).
How Does the Increased 401(k) Limit Affect Me?
If you hit the $19,500 contribution cap in 2021, this limit increase is good news for you, as you can choose to increase your contributions up to the limit to continue fully funding your account.
If you contribute a lower amount to your account each year, the new limits may not affect you. In fact, only 8.5% of taxpayers who contribute to direct contribution plans like a 401(k) contributed the maximum amount, according to Congressional Research Data from 2021. According to investment firm Fidelity, the average 401(k) contribution as a percent of salary was 9.4% in 2021. So, to hit the $19,500 cutoff in 2021 while saving the average income percentage, a worker would have made $207,447.
If you do qualify to contribute more in 2022 than in 2021 and want to do so, it's time to make a plan.
"Budgeting is the key," Hargrove says. "Prepare for the transition by building the funds you'll withhold into your budget."
The Bottom Line
Whatever your income, aim to optimize the tax benefits provided by a retirement plan by setting an attainable goal and striving to meet it.
At a minimum, always exhaust your employer's 401(k) contribution match. Not taking advantage of their match is essentially leaving free money on the table.
After maxing out your employer's match, how much you should contribute will depend on your unique financial situation and long-term goals. Experts recommend contributing 15% of your pretax income to a retirement plan annually. Weigh the value of the positive interest your contributions will accrue against the negative interest of any debt you carry. Then, devise a plan for contributing to retirement while also paying down debt.
If you aren't sure where you stand, reach out to a financial planner for personalized advice on a retirement plan strategy that works best for you.