Prepare For 2022: Tax Implications For Retirement Accounts

On November 4, 2021, the Internal Revenue Service (IRS) announced cost-of-living adjustments to retirement-related account limits for the tax year 2022. Details regarding the announcement are available in IRS Notice 2021-61. You may be wondering how these changes impact the everyday taxpayer and what actions you might need to take, if any? Let's explore the details of these changes and what it means for you. 

Contribution Limits are Increasing for Employer-Sponsored Accounts

If you work for an employer that offers a 401(k), 403(b), or similar plan, the elective deferral limitation has increased to $20,500. That's a fancy way of saying you can now contribute up to $20,500 to your employer-sponsored retirement account. This change represents a $1,000 increase over the previous tax year, 2021, when the limitation was $19,500 per year. If you are age 50 or older, you may contribute an additional $6,500 to your retirement account. If your employer sponsors a retirement account, you may want to take advantage of this opportunity to save for your future retirement goals. To illustrate the value of this benefit, assuming you can take full advantage of this benefit and contribute $20,500 in 2022. Without contributing any additional funds, that $20,500 could grow to $95,550 in 20 years with an 8% return. The chart below shows the impact if you continue contributing your annual amount over a specified number of years.  

[1] Ending balance assumes a monthly contribution of $2,562.50 at the end of each month

As shown in the table above, the elective deferral maximum of $20,500 ($27,000 if you are 50 or older) in 2022 only limits the contributions that you can make as an employee. Employer contributions are subject to a different limitation. The combined amount of employee and employer contributions in 2022 cannot exceed the lesser of the employee's compensation or $61,000.  

Traditional and Roth IRA Contribution Limits & Deductibility Remain the Same in 2022  

While the elective deferral limit has increased, contribution limitations for Traditional IRAs and Roth IRAs remain unchanged in 2022 as they have been since 2019. Contributions to these accounts are limited to $6,000 (individuals aged 50 or over may deposit an additional $1,000 for a total of $7,000). Additionally, eligible taxpayers may still deduct up to $6,000 in Traditional IRA contributions.   

Phase Out Ranges are Changing

While the elective deferral amount represents the most significant change to contribution limits, some phase-out modifications are also changing. Depending on your circumstances, a phase-out range identifies the income level you are either limited to or completely ineligible to receive the tax benefit. Let's explore the various phase-outs and how they might impact you.  

Traditional IRA

Remember that the Traditional IRA is a tax-advantaged savings plan where the total contribution, or a portion of it, is tax-deductible. Funds, however, are taxable upon distribution. If you are single and covered by a workplace retirement plan (regardless of whether you participate), your contributions are entirely deductible only if your income is less than $68,000 in 2022 ($66,000 in 2021). If your income is between $68,000 and $78,000, your contribution will only be partially deductible. The tax deduction completely phases out once you reach $78,000 in income.  

The phase-out thresholds are slightly different for married couples. If you file a joint return and a workplace retirement plan covers one spouse and the other is not, two separate rules apply:

• Scenario 1: Jeff and Angel are married, file a joint return, and are both covered by a workplace retirement plan. If Jeff and Angel's modified adjusted gross income (MAGI) in 2022 is between $109,000 and $129,000, contributions to their IRA will be limited. If their MAGI is greater than $129,000, they will be unable to deduct any contributions to their traditional IRA. The phase-out limitation range has increased since 2021, allowing a greater amount of income to be eligible for Traditional IRA deductions.  

• Scenario 2: Richard and Suzanne are married and file a joint return. A workplace retirement plan covers Suzanne, but Richard is not. In 2022, Richard and Suzanne will have a limited traditional IRA deduction if their MAGI is between $204,000 and $214,000 (increased from $198,000 - $208,000 in 2021). This rule allows greater deductibility for a couple that is partially covered by workplace retirement plans.

The phase-out range for married couples who file separate returns and are covered by workplace retirement plans remains unchanged in 2022. Traditional IRA contribution deductions are limited for MAGI up to $10,000 and completed eliminated above $10,000. 

Roth IRA

The Roth IRA is also a tax-advantaged retirement savings plan where contributions are NOT deductible; however, qualified distributions are tax-free. The Roth IRA is only available under strict income limitations. For 2022, the limits have increased as follows:

• Single and Head of Household Filing Status – Limited contributions are allowed with income between $129,000 and $144,000 ($125,000 to $140,000 in 2021)

• Married Filing Joint Filing Status – Limited contributions are allowed with income between $204,000 and $214,000 ($198,000 to $208,000 in 2021)

• Married Filing Separate - $0 - $10,000 (no change from 2021)

If your income exceeds the phase-out limit, you are typically ineligible to contribute to a Roth IRA. Nevertheless, possibilities for what is known as the "Back Door Roth IRA" are available. This option enables you to benefit from tax-free distributions. The "Back Door Roth IRA" can be accomplished in several ways: 

• Contribute funds to a Traditional IRA and convert your contribution to a Roth IRA

• Convert an entire Traditional IRA into a Roth IRA

• Make an after tax contributions to a 401(k) and then roll that over into a Roth IRA

Back Door Roth IRA options allow higher-income earners to take advantage of tax-free distributions. Keep in mind this may have a tax impact, so be prepared to pay taxes on your Traditional IRA gains. Before making any of these moves, consult your tax professional to verify you've crossed every "T" and dotted every "I." 

Before you get too excited about the Back Door Roth, you should familiarize yourself with the tax provisions proposed by the Build Back Better Act (H.R. 5376). The proposal has passed the House of Representatives. This bill includes language that prohibits all employee after-tax contributions to a qualified plan from being converted to a Roth, among various other legislation. If enacted, this bill would apply to distributions, transfers, and contributions made after December 31, 2021. More to come on this when more information is available.  

Saver's Credit

Last but not least are the phase-out ranges for the Saver's Credit. In 2022, the Saver's Credit or Retirement Savings Contributions Credit is available for married filing joint taxpayers making less than $68,000, head of household making less than $49,500, and singles/married filing separate making less than $34,000. To be eligible for the Saver's Credit, taxpayers must make eligible contributions to an IRA or workplace retirement plan. In addition to being age 18 or older, not be claimed as a dependent on anyone else's tax return, and not be considered a student. 

As with all tax information, it is good to be knowledgeable of the changes in tax legislation and how they may impact your financial situation. While conducting your research, be sure that you are also working with a qualified tax professional familiar with the ins and outs of your tax situation.