2023 UPDATE

Tis the season. Every October the IRS publishes their updated numbers for the following year. Everything from 401K contribution limits, annual gift exclusions, and the new tax rates.

You are maxing out your retirement savings, correct?

Maxing out your 401K in 2021

Do you have a 401K at work? If so, limits haven’t changed that much compared to 2020.

• You may contribute up to $19,500 of earned income to your 401K in 2021

This contribution limit also applies to 403(b) plans, most 457 plans, and the federal government’s Thrift Savings Plan.

Keep in mind, that if you are age 50 or above, you are allowed an additional “catch-up” contribution of $6,500.

• Those age 50 and above may contribute up to $26,000 of earned income to your 401K in 2021

Can more than that go into your 401K in 2021? Yes, your employer can contribute to your 401K as well. Many employers offer a “match”: for every dollar you contribute, they will also contribute, up to a set threshold. For example, perhaps your company offers a 3% match, and you make $100,000. You contribute $10,000 and they contribute $3,000 (3% of 100K) for a total of $13,000.

If you are self-employed you may contribute as both an individual and as an “employer”.

However, there are additional limits on how much you can contribute to yourself as an employer, based on the type of entity you are (e.g., sole proprietorship, S-corp, etc.), whether you have employees, and how much you—as the employer—contribute to the 401K accounts of those employees. (Under most circumstances, you can’t contribute to your own 401K account and cut out your employees.)

Another limit is that an employer can’t contribute more than 25% of an employee’s salary to their retirement account. For example, if an employee makes 50K, an employer can only contribute up to $12,500.

• In 2021 $58,000 is the absolute most that can be contributed to a 401K account

This is from all sources, both employee and employer. If you have two jobs (sequentially or concurrently) you also can’t go over this limit.

This is up from $57,000 in 2020.

If you are age 50 or above, you still get your catch-up contribution of $6,500, so the total for you is $64,500.

For example. Perhaps you are self-employed, age 40, have no employees, and file your taxes as an S-corp. You contribute $19,500 of your “salary” to your solo-401K. Then as the “employer” you contribute the difference of ($58,000 – $19,500 = ) $38,500.

Or you could contribute nothing from your salary and contribute the entire $58,000 as an employer. (Assuming your salary was over 58K x 4 = $232K.)

(As always, seek out a good tax advisor to determine the best path forward.)

Perhaps you’re not self-employed, but like most of us, a rank-and-file employee, with a not-particularly-generous employer. Yes, you can contribute more than $19,500 to your 401K! Again, you can’t go over the $58,000 limit, but—assuming your plan allows it—you can make additional “after-tax” contributions. More on that HERE.

How much do you need to make to get the maximum $58,000 contribution with a 401K?

$58,000 is a lot of money, but for the limits to work mathematically you need to make quite a bit to get that kind of savings

• ($58,000 – $19,500) / .25 = $154,000 is the salary you would need, to receive the maximum contribution in 2021 from a 401K

(If you are making after-tax contributions, you simply need to earn what you contribute. You need to earn $58,000 to contribute $58,000.)

Maxing out your SEP-IRA in 2021

If you are self-employed (or work for a small business), you may have a SEP-IRA instead.

SEP plans only take contributions from employers, but not employees. As above, that contribution is limited to 25% of compensation, and can’t go over $58,000.

How much do you need to make to get the maximum $58,000 contribution with a SEP-IRA?

If you are self-employed and make a decent living, you probably want to switch from a SEP to a 401K.

• $58,000 / .25 = $232,000 is the salary you would need, to receive the maximum contribution in 2021 from a SEP-IRA

Maxing out your SIMPLE-IRA in 2021

SIMPLE IRAs are also popular with the self-employed. Like the SEP-IRA little paperwork is required for set up.

• As an employee, you may contribute up to $13,500 of earned income to your SIMPLE in 2021
• If you are age 50 or older, you may contribute an additional $3,000, for a total of $16,500

Employers are also required to contribute to SIMPLE plans: either a 3% match or 2% non-elective contribution. Employers choose one method or the other.

A match requires that the employee contribute first. Assuming you make $100K, you would need to contribute $3,000 to get $3,000 from your employer.

Alternatively, if your employer chooses, you contribute nothing, but still get $2,000 (2%).

How much do you need to make to get the maximum $27,000 contribution with a SIMPLE-IRA?

Again, if you are self-employed and make decent money, it is difficult to max out your plan. And the maximum is only $27,000 ($13,500 x 2) or $30,000 for the over-50 set. Consider switching to a 401K plan.

• $13,500 / .03 = $450,000 is the salary you would need, to receive the maximum contribution in 2021 from a SIMPLE-IRA

IRA 2021 contribution limits, and phaseouts

In addition to your employer-sponsored plans is the humble individual retirement account, IRA.

• For 2021, your IRA contribution is unchanged at $6,000
• If you are age 50 or older, you may contribute $1,000 more or $7,000 total

There are two types of IRAs, traditional and Roth. You may contribute to one or the other, or both, as long as you don’t go over the $6,000 (or $7,000) limit for all of your contributions.

Reminder, this needs to be “earned” income from a job or business. (But non-working spouses can still contribute to an IRA if the other spouse earns.)

Simply put, the traditional IRA allows you to save taxes now, but pay later when you take the money out. A Roth IRA (or Roth 401K account) will charge you taxes now, but later all the money comes out tax-free.

A lot goes into deciding which is best for you. Under most circumstances, the Roth is better. Eventually that $6,000 will grow to $60,000 (after thirty years and around 7.4% interest, for example). When you go to take it out of your traditional IRA, you’ll owe taxes on the entire $60K.

However, if that account was a Roth, you paid taxes on the original 6K, but now the remaining $54K is tax-free!

If you go the traditional route, in theory you should be setting aside your tax savings in a separate taxable account and allow that to grow as well. (But let’s be honest, nobody ever does that.) This strategy will help but considering that money is taxed every year for thirty-plus years, it won’t make as much as the Roth strategy.

Roth IRA salary limitations in 2021

Unfortunately, if you make good money, you’re not allowed to contribute to a Roth IRA.

• For singles (and head of household), in 2021 you can contribute to a Roth if you make an adjusted gross income (AGI) of less than $125,000
• For those married-filing-jointly (MFJ), in 2021 you can contribute to a Roth if your AGI is less than $198,000

For both singles and MFJ there are phaseout ranges where you can contribute a smaller amount. Those phase-out ranges are $125-140K for singles and $198-208K for MFJ.

Hopefully, you have access to a Roth account in your 401K at work. Those have no income limitations.

If you find yourself with a high salary you are also paying high taxes, so the traditional route may look more appealing…  However, it turns out that route may also be limited…

Traditional IRA deduction phaseouts in 2021

Assuming you have earned income, you can always contribute to a traditional IRA, but if you make good money, it may not be deductible. In other words, you may not get that initial tax savings.

This is only an issue if either you or your spouse actively participates in a retirement plan at work (like the 401K, 403(b), SEP, or SIMPLE plans mentioned above).

• In 2021, for a single active participant, the phaseout is an AGI of $66,000 – $76,000

In other words, if your AGI is less than $66K you can either contribute to a Roth or a traditional IRA and get the tax deduction for the latter.

If you make $80K, you can contribute to either, but you won’t get the deduction for the traditional. Contributing to the Roth is a no-brainer.

At $130K neither choice is looking good, but more on that below…

• In 2021, for MFJ, where only one spouse is the active participant, the phaseout is an AGI of $198,000 – $208,000
• In 2021, for MFJ, where both spouses are active participants, the phaseout is an AGI of $105,000 – $125,000

What if you exceed all these limitations? Should you still contribute to an IRA. Assuming you’ve already maxed out your 401K (or similar) first, yes, you should still contribute.

You will be contributing what is referred to as “after-tax” money to your traditional IRA. You won’t get the initial tax deduction. But the money does grow tax-free. At some point down the line, you also have the option of doing a Roth conversion, and paying the taxes at that time.

Look! You just made the equivalent of a Roth contribution, but in a roundabout way.

Savers Credit in 2021

All this talk of those who “earn too much.” What if you are on the opposite end of the income spectrum? The IRS has provided the Savers Credit for you. If you contribute up to $2,000 to a qualified plan (e.g., an IRA or your 401K) you may be eligible for a tax credit of up to 50%, or $1000 ($2,000 for MFJ).

• In 2021, single taxpayers are eligible for the full 50% Savers Credit with an AGI under $19,500
• With an AGI between $19,500 and $33,000 the credit is reduced (20%, or 10%)

Tax credits come directly off the taxes that you owe. However, if you’re making less than $19,500 you are definitely not paying $2,000 in taxes (more like < $700), but you can certainly wipe out what you do owe.

• In 2021, MFJ taxpayers are eligible for the full 50% Savers Credit with an AGI under $39,500
• With an AGI between $39,500 and $66,000 the credit is reduced

If you qualify as a head of household, the limit is an AGI below $29,625, with a phaseout between $29,625 and $49,500.

2021 Tax brackets

At the same time, the IRS announced inflation-adjustments to the current tax brackets.

• For 2021, the standard deduction has been raised to $12,550 for singles, $18,800 for head of household, and $25,100 for MFJ

The standard deduction is subtracted from your adjusted gross income (AGI) to generate your taxable income. Think of it like a “zero percent” tax bracket. The first $12,550 you make is not taxed.

If you itemize, you may have more to deduct than the standard amount. You make even more money tax-free.

After the standard (or itemized) deduction, the next bit of taxable income is taxed at ten percent, then the next bit is taxed at 12% and so on.

(Remember, the percentages in the table below are applied AFTER the standard—or itemized—deduction is subtracted.)

[Phone users, turn your phone sideways for better viewing.]

Alternative Minimum Taxes

For those on the upper end, you may be subject to the Alternative Minimum Tax (AMT). Your taxes are calculated in two ways, the regular way, and the AMT way. You pay the higher tax.

• In 2021, for singles the AMT exemption is $73,600 and begins to phase out at $523,600
• For MFJ the exemption is $114,600 and phases out at $1,047,200

In other words, if your AGI is below $73,600 you don’t need to worry about the AMT.

2021 Capital gains tax rates

In addition to your retirement accounts, you may have savings invested within a taxable account, such as a brokerage account. If these products have increased in value AND you’ve held them more than one year AND you sell them in 2021, you may be subject to capital gains taxes.

(Profit from selling investments that you’ve held for less than a year are short-term capital gains and are taxed just like income above.)

• For 2021, singles with taxable income below $40,400 pay zero taxes on long-term capital gains

Obviously, you still owe taxes on your regular income, which you receive from your paycheck or business. Above a taxable income of $40,400, you may owe 15% (or perhaps 20%) on capital gains.

Note that regardless of your taxable income, you’ll always owe less on capital gains than you will on your regular income.

Top photo credit: © Olya Kobruseva via Canva.com

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