Each fall, the IRS announces retirement plan limits for the next year. In November 2021, we detailed those 2022 plan limits on our website.
As we write this, we’re almost halfway through the year. Here are some tips to take advantage of the 2022 IRS retirement plan limits.
Maximize Your Contributions
The standard contribution limit for employee salary deferrals to a qualified retirement plan – 401(k), 403(b), most 457 plans, and the government’s Thrift Savings Plan – is $20,500 for 2022.
Tip: If you’re not maximizing your salary deferral contributions, contact your employer’s H/R department or your plan administrator, and have your deferrals increased for the rest of the year, so that you reach the maximum.
Don’t Forget Catch-Up Contributions
The “catch-up” deferral limit for these plans is $6,500 for 2022, so if you’re age 50 or older in 2022 you can defer a maximum of $27,000 this year (your $20,500 regular deferral plus a $6,500 catch-up).
Tip: When you contact your employer’s H/R department or your plan administrator, make sure that your salary deferrals include the catch-up amount.
SEP IRAs and Solo 401(k) Accounts
The contribution limit for a SEP IRA in 2022 is the lesser of (a) $61,000, or (b) 25% of the employee’s salary. Remember that a special computation is required to determine the contribution amount for self-employed individuals contributing for themselves. The compensation limit used in the savings calculation is $305,000 for 2022.
The contribution limit for a Solo 401(k) in 2022 is the lesser of (a) $61,000, or (b) 100% of your salary. Note that solo 401(k) plans also permit catch-up deferrals, so if you’re age 50 or older you can contribute a maximum of $67,500 in 2022.
Tip: If you’re able to, consider switching from a SEP IRA plan to a solo 401(k), since the permitted contribution amount can often be more favorable with the 401(k) plan. Talk with your CPA, accountant or financial advisor for guidance.
Contribute to an IRA or Roth IRA
If your income isn’t too high, you can contribute to an IRA or Roth IRA in addition to your employer-sponsored plan. The contribution limits for Traditional and Roth IRAs are $6,000 for 2022. IRAs and Roth IRAs also have catch-up contributions, so if you’re age 50 or older you can make an additional $1,000 contribution in 2022, for a total of $7,000.
Tip: Talk with your CPA, accountant or financial advisor to determine whether you’re permitted to make a contribution to an IRA or Roth IRA, based on your income. If your income is too high, you may want to make a “backdoor” Roth IRA contribution instead.
Use a Backdoor Roth IRA if Necessary
If your income is too high, it’s quite possible that you (and perhaps your spouse, if you’re married) make too much money to meet the income limit. When your “modified adjusted gross income” (or “MAGI”) exceeds a certain level, the IRS starts gradually phasing out the amount you can contribute to a Roth IRA, eventually eliminating the permitted contribution altogether.
Fortunately, there’s an increasingly common – and legal – strategy to get around that. It’s known as a “backdoor” Roth IRA.
The easiest way to make a backdoor Roth contribution is to make a non-deductible contribution to a traditional IRA and then roll over the IRA funds to a Roth IRA account.
Note that if you have an existing traditional IRA account that you funded with pre-tax dollars, the backdoor Roth contribution strategy can have some unintended tax consequences. In this case, you should consult with your tax professional or financial advisor before taking any action.
Tip: Watch out for the IRS’s pro rata rule, if you already have an existing IRA with pre-tax contributions.
Should You Use the Mega Backdoor Roth Strategy?
Every year, the IRS limits the total amount that can be contributed to your qualified retirement plan account, like a 401(k). This is known as the annual additions limit.
The annual additions limit includes your regular salary deferrals, catch-up contributions, employer matching or profit-sharing contributions, as well as forfeitures, etc.
For 2022, the annual additions limit is $61,000. If you’re age 50 or older, there’s an additional $6,500 catch-up contribution amount, so your limit is $67,500.
What if you have the ability to save more for retirement, but you’re “limited” by the IRS’s annual additions limit? That’s where this strategy comes into play.
Let’s look how this Mega Backdoor Roth strategy – formally known as “after-tax contribution with in-plan Roth conversion” – works in practice.
Let’s say that you’re 52 this year, and you’re able to contribute the maximum to your employer’s plan: $27,000. In addition, your employer makes a generous matching contribution to your account, 100% of the first 10% of your income. Because you earn $180,000, your $27,000 contribution is equal to 15% of your income ($27,000 is 15% of $180,000). So, your employer will match 100% of your contribution up to 10%, or $18,000 (10% of $180,000 is $18,000).
As a result, the additions to your account total $45,000. This is obviously less than the annual additions limit of $67,500 for this year. There’s “room”, so to speak, for an additional $22,500 in account contributions ($67,500 – $45,000).
So, assuming (a) your employer’s plan permits this, and (b) you have the financial ability to do so, here’s how you implement this strategy:
- First, make non-deductible, after-tax salary deferrals into your 401(k), above and beyond your normal salary deferrals
- Next, immediately convert these after-tax salary deferrals to a Roth account
- Potentially, if your employer’s plan permits, roll these Roth balances to a Roth IRA
Tip: Check with your plan’s administrator to see if “after-tax contributions with in-plan Roth conversion” are permitted.
If you need help with planning for retirement, consider working with a Certified Financial Planner™ (CFP®) or a Retirement Income Certified Professional® (RICP®). Advisors who hold these designations had to meet rigorous educational, experience and ethics requirements.