Amidst Rising Inflation, IRS Boosts 401(k) and IRA Contribution Limits by Record Amounts

On October 21, 2022, the IRS announced a record increase in retirement plan contribution limits for 2023. The new limits apply to most types of defined contribution plans as well as Individual Retirement Accounts (IRAs). With inflation currently running at 8.2%, the new contribution limits will let workers to put more of their pre-tax earnings into retirement accounts, allowing them to both save on current taxes and beef up their retirement funds.

If you make contributions to a defined contribution plan, an IRA, or both, the new limits could mean lower taxes and more money for retirement.

Defined Contribution Plans
Defined contribution plans allow an employee, employer, or both to contribute to the employee’s retirement account. These plans are tax-deferred, meaning the employee does not pay tax on the money they contribute, though they do pay tax on withdrawals made after retirement.

The new limits apply to 401(k)s, 403(b)s, most 457 plans, and the Thrift Savings Plan. Briefly, 401(k) are generally sponsored by for-profit organizations, 403(b)s by not-for-profits, 457s are offered by state and local public employers, such as school districts, and the Thrift Savings Plan (TSP) was created for employees of the Federal Government.

Defined contribution plans have been indexed to inflation since 2007. This year’s increases mark the biggest single jump on record.

Individual & Employer Contributions
In 2023, the maximum amount that employees can contribute to their defined contribution plans will increase by almost 10% from $20,500 to $22,500. Employers who offer matching funds will be able to contribute up to 20% of up to $330,000 of an employee’s compensation, for a maximum of $66,000 a year, an 8.1% increase from the $61,000.

Solo 401(k)s
Solo 401(k)s allow self-employed individuals with no full-time employees to save for retirement using pre-tax income for contributions. They are funded by a combination of employee contributions and earnings. Employee contributions have the same limit, $22,500, as other 401(k)s. The earnings limit is equivalent to the employer matching funds, meaning that self-employed people can contribute up to 20% of up to $330,000 in earnings, up from the current $305,000. This makes the new limit for contributions $66,000, up from $61,000.

Catch-up Contributions
Employees aged 50 or older are allowed to contribute more to their plans than younger people. The new rules raise the catch-up contribution limit from $6,500 to $7,500, meaning that older employees will be able to contribute up to a total of $30,000.

Individual Retirement Accounts (IRAs)
IRAs are personal retirement savings accounts available to anyone with earned income. There are several types of IRAs, each with its own unique advantages. Unlike defined contribution plans, IRAs are not subject to regular cost-of-living adjustments. Starting in 2023, however, the IRS is making changes to both contribution and income limits.

Traditional & Roth IRAs
The two most common IRAs are traditional IRAs, which are tax-deferred, and Roth IRAs, which are funded with taxed contributions but can be withdrawn tax-free at retirement. The IRS is raising the contribution limit for traditional and Roth IRAs by more than 8%, from the current $6,000 to $6,500.

The income phase-out range at which tax-deferred IRA contributions are no longer tax deductible is being raised for both single and married filers:

• Single taxpayers covered by a workplace retirement plan: from $73,000 to $83,000 (up from $68,000 and $78,000 in 2022)
• Married couples filing jointly, if the spouse making the IRA contribution is covered by a workplace retirement plan: from $116,000 and $136,000 (up from $109,000 and $129,000 in 2022)
• IRA contributor not covered by a workplace retirement plan and married to someone who is covered: from $218,000 and $228,000 (up from $204,000 to $214,000 in 2022)
• Married individual filing a separate return who is covered by a workplace retirement plan: from $0 to $10,000 (no change)

For Roth IRAs, the income range for which eligibility phases out will also be set higher:

• Single filers and heads of household: from $138,000 and $153,000 for (up from between $129,000 and $144,000)
• Married couples filing jointly: from $218,000 to $228,000 ($204,000 and $214,000)
• Married individuals filing separately: from $0 to $10,000 (no change)

SEP & SIMPLE IRAs
Simplified Employee Pension (SEP) IRAs are designed for small business owners and self-employed people. As of 2023, they will allow tax-deductible contributions of either 25% of an employee’s pay or $66,000, whichever is less. This represents an over-8% increase from the current limit of $61,000.

The Savings Incentive Match Plan for Employees (SIMPLE) IRA was also designed for small businesses and allows employees and employers to contribute to a traditional IRA. As of 2023, the amount that individuals can contribute will increase from $14,000 to $15,500.

Catch-up Contributions
For traditional and Roth IRAs, the catch-up contribution limit for individuals aged 50 or older remains the same at $1000, for a total of $7500.

The catch-up contribution for SIMPLE IRAs rises from $3000 to $3,500. There is no catch-up contribution for SEP IRAs.

Retirement Savings Contributions Credit (Saver’s Credit)
The Retirement Savings Contributions Credit, also known as the Savers Credit provides a special tax break to low- and moderate-income taxpayers who are saving for retirement, allowing them to claim the credit for 50%, 20% or 10% of the first $2,000 they contribute to a retirement account in a tax year.

As of 2023, the income limits for the Savers Credit increase in the following categories:

• Married couples filing jointly: $73,000 (from $68,000)
• Heads of household: $54,750 (from $51,000)
• Singles and married couples filing separately: $36,500 (up from $34,000)

How Much Will You Contribute?
Only about 8.5% of employees with access to deferred contribution plans make the maximum possible contributions, and the majority of Americans aren’t saving enough for retirement. The IRS’s new limits will hopefully encourage people to save more for the future while taking advantage of tax deductions in the present.

If you have questions about how your retirement savings or your tax responsibilities could be affected by these new limits, contact us today.