One of the many ways that financial advisors offer value to their clients is by helping them diversify and rebalance their portfolios. This mentality can also extend to their employer-sponsored retirement plans. In addition to helping clients choose investments and diversify their portfolio, advisors can help their clients lower their adjusted gross income in the current year and provide more options when designing retirement withdrawal strategies.
In November, the IRS announced changes to retirement plans for 2022 allowing employees under the age of 50 to contribute up to $20,500 per year to their 401(k), an increase of $1,000 from 2021. The catch-up contribution for employees age 50 and older remains unchanged at $6,500, for a total contribution limit of $27,000. The combined total employer and employee contributions cannot exceed $61,000 for the year, and $67,500 for employees age 50 and older.
Traditional and Roth IRA contribution limits remain unchanged at $6,000 per year, with an additional $1,000 per year catch-up contribution for those age 50 and older. However, advisors should note that the income phase-out ranges have gone up for 2022. For example, the income phase-out for Roth IRA contributions for 2022 is $204,000 to $214,000 for married filing jointly, compared with $198,000 to $208,000 for 2021.
Advisors can provide tremendous value to their clients by helping them implement tax saving strategies such as maxing out their 401(k) contributions, which can help them save taxes both now and in the future. Here are a few ways advisors can help clients plan their contributions:
— Helping clients plan ahead.
— Lowering clients’ gross income.
— Exploring Roth 401(k) contributions.
— Explaining limitations for highly compensated employees.
[SUBSCRIBE: Get the weekly U.S. News newsletter for financial advisors. ]
Helping Clients Plan Ahead
The beginning of the year provides a great opportunity for financial advisors to help their clients make the necessary adjustments in their paychecks, in order to max out their 401(k) contributions as evenly as possible throughout the year. This helps avoid having to increase their contributions at the end of the year if a client is not on track to maxing out their 401(k) contributions. Making contributions earlier in the year will also be beneficial since they will be invested longer.
Lowering Clients’ Gross Income
Making contributions to a 401(k) can create many tax benefits. The most immediate benefit is lowering a client’s taxable income, since the contributions to a traditional 401(k) are made pretax. However, there are other benefits that can help clients save even more on taxes. When advisors help their clients lower their adjusted gross income, it can also benefit them in other areas:
— Keeping their Medicare Parts B and D premiums lower.
— Lowering their capital gains rate. For example, from 15% down to 0%.
— Avoiding the net investment income tax of 3.8%.
— Staying under the income limits to be eligible to contribute to a Roth IRA.
— Qualifying for the Lifetime Learning Credit or the American Opportunity Credit.
— Taking advantage of the student loan interest deduction.
If a client expects to be in a lower tax bracket when they retire, contributing to a 401(k) now will also provide some tax savings in the long run.
Exploring Roth 401(k) Contributions
Many companies offer a Roth 401(k) option, so advisors should ask their clients for a copy of their plan document to see if a Roth option is available. Contributing to a Roth 401(k) offers additional tax planning opportunities. A client that is in a lower tax bracket now and expects to be in a higher tax bracket in the future can benefit by contributing to a Roth 401(k) because they’ll be locking in the taxes on those contributions now. For example, a married couple may be in a lower tax bracket because one of them is out of work to attend school or raise kids, and expects to enter the workforce in later years. The couple can take advantage of contributing to a Roth 401(k) while they are in the lower bracket.
In addition, a Roth 401(k) can offer tax diversification in retirement. Just as advisors diversify client portfolios, they can help clients diversify their tax strategy in retirement. A Roth 401(k) can be rolled over into a Roth IRA, and the distributions can be tax-free and penalty-free. Earnings can be tax-free and penalty-free as well, provided that they are done after age 59 and a half and meet the five-year rule.
By having a tax-diversified strategy, advisors can help clients determine where to withdraw funds from in retirement in order to help minimize their tax burden. Qualified Roth IRA distributions will not affect adjusted gross income, and can therefore help clients by not affecting their Medicare Parts B and D premiums, or by lowering or avoiding taxes on their Social Security income.
[READ: Learn From Billionaires: Investors Should Consider Selling Stock Positions.]
Explaining Limitations for Highly Compensated Employees
Unfortunately, not all employees can take advantage of the maximum 401(k) contribution limits. Individuals considered highly compensated employees, or HCEs, will be limited as to how much they can contribute to their 401(k). The IRS’ definition of an HCE is as follows:
— An employee who owns more than 5% of the company at any time during the year or the preceding year, regardless of their compensation.
— An employee who earns more than $135,000 in 2022 ($130,000 in 2021) and is in the top 20% of employees by compensation, if the company makes a “top-paid” election.
Finding out if a client is a highly compensated employee as early as possible will make time to explore other planning opportunities, such as contributing to an IRA or a health savings account.
More from U.S. News
What Is a Financial Coach and How to Become One
Q&A: How to Make 2022 Your Best Year Yet as a Financial Planner
What Is an Irrevocable Life Insurance Trust and Do You Need One?
2022 401(k) Contribution Limits: What Advisors Should Know originally appeared on usnews.com
