The IRS just released the inflation adjusted retirement plans maximum contribution amounts for 2023, and the increases are dramatic. So, this may be the time to start considering funding a retirement plan if you don’t currently have one. If you are already contributing to a tax-favored retirement plan and are looking for ways to increase your annual contribution, these inflation increases will be good news.
Here’s a rundown on the various tax-favored retirement plans available and the inflation adjustments pertaining to each.
Your 401(k), IRA or other retirement accounts may be a tempting source for cash if you find yourself short of funds or have a major purchase you are considering. But withdrawing money from a traditional IRA or qualified retirement account before you reach age 59 1/2 may not be the best idea, as you will likely pay both income tax and a 10% early-distribution tax (also referred to as a penalty) on any previously untaxed money that you take out.
Withdrawals you make from a SIMPLE IRA before age 59 1/2, and those you make during the 2-year rollover restriction period after establishing the SIMPLE IRA, may be subject to a 25% additional early-distribution tax instead of the normal 10%. The 2-year period is measured from the first day that contributions are deposited.
These penalties are just what you’d pay on your federal return; your state may also charge an early-withdrawal penalty in addition to the regular state income tax.
Thus, before making any withdrawals from a traditional IRA or other retirement plans, including a 401(k) plan, a 403(b) tax-sheltered annuity plan, or a self-employed retirement plan, there are two things you should carefully consider: (1) you are taking funds, and their future appreciation, from your retirement savings which can impact your future retirement lifestyle. (2) You will be creating unnecessary taxes and penalties which will increase the amount you will need to withdraw to obtain your needed funds.
Like many small business owners, you probably find yourself very busy in the wake of the COVID slowdown and are getting back up to speed. But don’t forget about your future.
There are a number of retirement plans available, including Keogh plans and 401(k)s. However, a simplified employee pension plan (SEP) may be your best option.
The reason a SEP is “simplified” is that its retirement contributions are deposited into a traditional IRA account under the control of the SEP participant, thus eliminating most of the employer’s administrative duties. That is why these plans are sometimes referred to as SEP-IRAs. SEPs function much like Keogh retirement plans, and they allow tax-deductible contributions for both employees and self-employed individuals. For an employee, the maximum contribution for 2021 is the lesser of 25% of that employee’s compensation or $58,000. These contributions are excluded from the employees’ wages and are not subject to withholding for income tax or FICA. A self-employed person can contribute 25% of his or her compensation after deducting the employer’s contribution, which boils down to the smaller of 20% of the business’ net profit or $58,000. Each year, the employer can specify a compensation amount between zero and 25% (not exceeding the maximums for the year).
As part of the CARES Act, the requirement for older taxpayers to take required minimum distributions (RMDs) from their retirement plans was waived for 2020. This primarily was due to the anticipated drop in value for most investments as a result of the economic effects of COVID-19, which actually did not materialize.
So, barring any extension of the 2020 moratorium by Congress, RMDs must be resumed for the 2021 tax year.
The tax code offers two types of IRAs; one is referred to as the traditional individual retirement account (IRA), so named because it was the first type of IRA available, having been created by Congress back in the 1970s. The second type is the Roth IRA, established in 1997 and named after William Roth, who was a senator from Delaware. Which one is best for you?
If you are at or approaching the age of 70, you need to be aware of some changes that Congress made to the tax laws, effective starting in 2020. These changes will have direct impacts on you and the decisions you make related to your retirement accounts. Not only will they affect your federal taxes, but depending upon your state’s income tax laws, they may impact your state tax status as well.