Retirement Contributions – What are the Limits?
Each year, the IRS limits how much you can contribute to your tax-deferred retirement accounts. The limits are different for 401K vs. IRAs, as are the tax requirements.
Here’s everything you must know about retirement contributions.
What’s the Difference between a 401K vs. IRA?
A 401K is an employer-sponsored retirement account. The contributions come directly from your paycheck and appear as payroll deferrals on your W-2.
IRA contributions are made after tax, but you can take the deductions on your tax returns if you’re eligible.
Within each account, you may choose a traditional or Roth account. A traditional retirement account is with pre-tax funds. Your contributions and earnings grow tax-deferred, and you pay taxes based on your tax bracket when you withdraw the funds.
A Roth account is on after-tax funds. You contribute funds after you pay taxes. Your contributions and earnings are tax-free. As long as you withdraw funds after age 59 ½, you don’t pay taxes on your withdrawals.
The 401K and IRA have different contribution limits. These are annual limits, and they typically change each year.
There are limits for ‘ordinary contributions’ and ‘catch-up’ contributions for anyone 50 or older.
401K Contribution Limits
In 2022, the 401K contribution limits are $20,500 for workers age 50 and younger. Anyone over 50 can contribute an additional $6,500 for a total of $27,000.
IRA Contribution Limits
In 2022, the IRA contribution limits are $6,000 for anyone under 50. You don’t need an employer to open an IRA. If you have earned income (or you’re married and your spouse does).
If you’re over 50, there’s an extra $1,000 contribution limit for a total of $7,000 in contributions.
What if you Over Contribute?
If you accidentally contribute too much, you’ll have tax consequences.
Over contributing to a 401K will require you to pay taxes twice. First, you’ll pay taxes on the ‘extra’ contributions, plus earnings in the year you contributed. Then you pay taxes again when you withdraw them.
If you over contribute to your IRA and don’t withdraw the funds, you’ll pay a 6% excise tax on the contributions and earnings each year until you withdraw them (including the earnings).
Keep in mind, on over contributions in either account, you will also pay a 10% penalty on the earnings withdrawn.
Pay close attention to your retirement account contributions. If you notice that you over contributed, talk to your advisor immediately and decide how to handle the funds. Usually, withdrawing the funds before that year’s tax due date has the most favorable effects.
You’ll owe taxes on the earnings and may be subject to a 10% penalty, or you may be double-taxed, so it’s crucial to watch your limits and diversify your efforts to save for retirement to avoid contributing too much.
If you have any questions about retirement account contributions or need help deciding how to save for retirement, contact the professionals at Murtha & Murtha CPAs today.