In addition to providing a cost-of-living adjustment to the tax brackets, the IRS announced cost-of-living adjustments to health savings accounts (HSAs) and retirement plans for 2023 as a result of inflation. This is great news for clients, since they can receive more income at the lower brackets and can contribute more to their retirement plans. This — combined with a Social Security cost-of-living adjustment of 8.7% starting in 2023 — provides great opportunities. Financial advisors can help their clients by planning ahead and taking advantage of the higher contribution and income limits.
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 portfolios, advisors can help them lower their adjusted gross incomes in the current year and provide more options when designing retirement withdrawal strategies.
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 things advisors should know to help their clients plan their contributions:
— Contribution limits for 401(k)s, 403(b)s, thrift savings plans and 457 plans.
— Traditional and Roth IRA contribution and income limits.
— Health savings account contribution limits.
— Helping clients plan ahead.
— Lowering clients’ gross income.
— Exploring Roth 401(k) contributions.
— Explaining limitations for highly compensated employees.
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Contribution Limits for 401(k)s, 403(b)s, Thrift Savings Plans and 457 Plans
In 2023, employees under the age of 50 can contribute up to $22,500 per year to their 401(k) and other retirement plans, such as 403(b)s, Thrift Savings Plans and most 457 plans — an increase of $2,000 from 2022. The catch-up contribution for employees ages 50 and older increased from $6,500 to $7,500 for a total contribution limit of $30,000 by the employee. The combined total employer and employee contributions cannot exceed $66,000 for the year in 2023, up from $61,000 in 2022, and $73,500 for employees ages 50 and older, up from $67,500 in 2022. The salary cap for all tax-qualified plans is $330,000, up from $305,000 in 2022.
Traditional and Roth IRA Contribution and Income Limits
Traditional and Roth IRA contribution limits have also increased for 2023. The maximum contribution amount is $6,500, up from $6,000 in 2022, with an additional $1,000 per year catch-up contribution for those age 50 and older.
Advisors should note that the income phase-out ranges have also gone up for 2023. The income phase-out for Roth IRA contributions for 2023 for single filers is $138,000 to $153,000 — up from $129,000 to $144,000 in 2022 — and for couples that are married and filing jointly, the income phase-out range is $218,000 to $228,000 — up from $204,000 to $214,000 in 2022. For married couples filing separately, the phase-out remains between $0 and $10,000. Those that exceed the income phase-outs may be able to take a contribution via a backdoor Roth IRA.
The income phase-out for traditional IRA contributions for 2023 for single filers covered by a workplace retirement plan is $73,000 to $83,000 — up from $68,000 and $78,000 in 2022 — and for couples that are married filing jointly, where the spouse making the contribution is covered by a workplace retirement plan, the income phase-out range is $116,000 to $136,000 — up from $109,000 to $129,000 in 2022. For married couples filing jointly where the IRA contributor is not covered by a workplace retirement plan, the income phase-out is $218,000 to $228,000 — up from $204,000 to $214,000 in 2022. For married couples filing separately the phase-out remains between $0 and $10,000.
Health Savings Account Contribution Limits
Contribution limits have also gone up for health savings accounts, or HSAs. For clients that have a high-deductible health insurance plan and qualify to contribute to an HSA in 2023, the self-only coverage limit is $3,850 — up from $3,650 in 2022. The family coverage limit is $7,750 — up from $7,300 in 2022. For those 55 and older, there is an additional $1,000 catch-up contribution.
Helping Clients Plan Ahead
The beginning of the year provides a great opportunity for financial advisors to help their clients make adjustments in their paychecks to max out their 401(k) contributions as evenly as possible throughout the year. This helps avoid having to increase contributions at the end of the year if a client is not on track to maxing out their 401(k) limits. Making contributions earlier in the year is also 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 help them:
— Keep their Medicare Parts B and D premiums lower.
— Lower their capital gains rate. For example, from 15% down to 0%.
— Avoid the net investment income tax of 3.8%.
— Stay under the income limits to be eligible to contribute to a Roth IRA.
— Qualify for the lifetime learning credit or the American opportunity credit.
— Take advantage of the student loan interest deduction.
— Qualify for the retirement contribution saver’s credit.
— 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 who is in a lower tax bracket now and expects to be in a higher tax bracket in the future can benefit 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 they expect 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 strategies 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 to help minimize their tax burdens. Qualified Roth IRA distributions will not affect adjusted gross income, and they 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.
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 $150,000 in 2023 — or $135,000 in 2022 — 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 HSA.
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2023 401(k) Contribution Limits: What Advisors Should Know originally appeared on usnews.com
Update 11/16/22: This story was published at an earlier date and has been updated with new information.
