We’re continuing with our series on New Year’s resolutions that you can do to improve your finances.? Be sure to read Part 1 for extra tips!
Pay Down Those Credit Cards
If you owe money on your credit cards, determine how much you can realistically afford to pay down during the year. For best results, try not to charge additional purchases on those cards while you’re trying to pay down what you owe. Download our (Microsoft Excel) debt/savings calculator to calculate how much you need to pay each month to pay off a debt.
Maximize Your 401(k) & 403(b) Plan Contributions
At work, you probably have the opportunity to save for your retirement through a 401(k) or 403(b) plan sponsored by your employer. The maximum annual contribution for 2013 has increased to $17,500. And anyone who will be 50 or older by December 31st can contribute an extra $5,500 this year. Remember, amounts contributed to these plans reduce your taxable compensation and grow tax deferred.
Unless you’re already on track to contribute the maximum to your 401(k) or 403(b) plan this year, now’s the time to instruct your employer’s benefit department to increase the percentage of your salary going towards this tax-advantaged retirement savings account.
And if you’re self-employed, set up a solo 401(k) plan or a SEP IRA plan as soon as possible, if you haven’t already done so, and try to contribute to these plans systematically over the year.
Contribute $5,500 to a Roth IRA
Roth IRAs are one of the few tax-free investments available to individuals. This year, you can contribute up to $5,500 to your Roth IRA. You won’t get a tax deduction, but amounts contributed grow tax-free, as long as certain conditions are met. Consider signing up with a mutual fund company to have $458.33 automatically transferred from your checking account into a Roth IRA each month.
Don’t forget, if you’re single and your adjusted gross income (AGI) exceeds $127,000 or married and your AGI exceeds $188,000, you’re not eligible to contribute to a Roth IRA that year. If your income exceeds the applicable threshold, you’re still eligible to contribute to a traditional IRA for that year. The amount contributed isn’t tax deductible if either you or your spouse is covered under a retirement plan at work, but grows tax-deferred. You can also convert your IRAs to a Roth IRA at any time under the current rules, no matter how high your income will be.
Take Advantage of the Tax-Free College Savings Opportunities
Money contributed to Education Savings Accounts (formerly Education IRAs) and 529 Plans grow tax-free, as long as any money withdrawn is used for tuition and certain other college expenses, or in the case of ESAs, for private elementary school or high school as well. You can contribute up to $2,000 per year per child into an ESA, and up to $14,000 per year, or frontload $70,000 at one time, into a 529 Plan, subject to certain restrictions. With tax rates on the rise, these tax-free opportunities become even more attractive to most taxpayers.
Avoid Resolution Pollution
Did you set so many financial goals that you’ll end up attaining none of them? If so, take this opportunity to restate your financial resolutions for 2013.
Contributing to a retirement plan is one of the best tax shelters available to you during your working years. Recently, the IRS announced that many of the retirement savings limits will increase for 2013.
Employer Sponsored Plans
Most working professionals have access to a 401(k) plan or a 403(b) plan at work. Amounts contributed to these plans generally reduce your taxable earnings and always grow tax deferred. For 2013, you can contribute up to $17,500 into a 401(k) or 403(b) plan through salary deferrals, up from $17,000 in 2012.
Looking to set your 2013 monthly budget? To max out your 401(k) or 403(b) salary deferrals next year, instruct your employer to withhold $1,458.33 per month from your pay.
Catch-up contributions remained the same as they were in 2012. Anyone 50 or older by December 31, 2013 can contribute an extra $5,500 into their 401(k) or 403(b) plan through salary deferrals next year, for a total annual contribution of $23,000, or $1,916.66 per month.
Many smaller employers offer their staff access to SIMPLE/IRAs instead. SIMPLE’s work just like 401(k) plans, which means it’s up to you to fund the bulk of this retirement savings account through salary deferrals. For 2013, the maximum contribution into your SIMPLE increases to $12,000, or $1,000 per month. Anyone 50 or older by December 31st can sock away an additional $2,500 in 2013, for a total annual contribution of $14,500, or $1,208.33 per month.
Are you self-employed? Each year, you can contribute up to 20% of your net self-employment income into a SEP IRA. The maximum contribution for 2013 is $51,000, or $4,250 per month, up from $50,000 in 2012.
Solo 401(k)’s are an attractive alternative to many sole proprietors and business owners with no full time employees who work more than 1,000 hours per year besides a spouse. If you don’t have access to a 401(k) or 403(b) plan through another employer, the Solo 401(k) plan makes it easier for you to hit next year’s max of $51,000. If you’re 50 or older, your maximum contribution into a Solo 401(k) jumps to $56,500, or $4,708.33 per month. You have until December 31st to set up a Solo 401k for 2012.
The IRS also announced that the maximum amount of wages and net self-employment income that you can use to determine certain retirement plan contributions has increased to $255,000 for 2013, up from $250,000 in 2012.
Don’t forget about IRAs. Even if you’re covered under a retirement plan at work, you and your spouse can each contribute up to $5,500 (up from $5,000 for 2012), or $458.33 per month, into a traditional IRA or Roth IRA next year, as long as your combined wages and net self-employment income exceeds the total amount contributed. Anyone 50 or older can contribute an extra $1,000, increasing the total allowable contribution to $6,500, or $541.66 per month.
Along with a $500 increase to IRAs for 2013, there is more good news for people looking to contribute to a Roth IRA . The amount you can earn and still contribute to a Roth has increased by $5,000 for married couples and by $2,000 for single individuals, as follows:
If your income is too high for a Roth, don’t forget that the rules changed a few years back, eliminating the income limitation as of 2010 for people looking to convert their IRAs to a Roth IRA. This tax law change provides high-income taxpayers with a great opportunity to get money into these tax-free investment accounts. For more information, please check out the article, The Re-Emergence of Non-Deductible IRAs, available on our March 2007 Newsletter or Keep on Converting in 2011 and Beyond, available in our March 2011 Newsletter.
And if you’re married and your spouse isn’t covered under either an employer sponsored or self-employed retirement plan during the year, the 2013 phase-out range for your spouse making a deductible IRA contribution has increased to $178,000 – $188,000, which is identical to the Roth IRA phase-out limits.
Re-Set Your 2013 Budget
Most people won’t be able to max out these tax-advantaged retirement options unless they get on a budget and put away a set amount of money each month. With 2012 winding down, now’s the time to start thinking about resetting your monthly retirement savings goals for 2013.
2013 Maximum Retirement Account Contributions
Retirement Savings Option
|Under the age
|50 or older by December ? 31st
401(k) or 403(b)
In Part 1, we discussed the differences and benefits of Traditional and Roth IRAs.? Today, I’d like to give you some advice on the amount you should be contributing.
The Max Factor:
When my clients ask me for advice about the Roth 401k or 403b plan, I immediately look at Box 12 of their W-2 forms to see how much they contributed in salary deferrals during the prior year. According to the instructions of the W-2 form, here are the relevant codes that show up in Box 12 of the W-2 form:
Code D – Elective deferrals to a section 401(k) cash or deferred arrangement. Also includes deferrals under a SIMPLE retirement account that is part of a section 401(k) arrangement.
Code E – Elective deferrals under a section 403(b) salary reduction agreement
Code AA – Designated Roth contributions under a section 401(k) plan
Code BB – Designated Roth contributions under a section 403(b) plan
What I’m looking to see is whether this client is maxing out their salary deferrals during the year. If a client is contributing to the Roth version of the 401k and 403b plan, and is falling short of the $17k max ($22.5k max if 50 or older), I strongly suggest that they consider contributing only to the Traditional version until they are able to max out their contributions.
In my opinion, socking away as much money as possible each year into these tax-advantaged, creditor protected accounts takes priority over worrying about saving taxes later. Remember, if money is tight, you have the choice of contributing $10,333 into a Roth 401k account, or taking advantage of the $6,667 tax break offered by traditional 401k plans and putting away the max of $17k into the Traditional 401k account.
I think a financial planning twist on Alfred Lord Tennyson’s poem about lost love sums this up best, “Tis better to save and be taxed than never to have saved at all.”
Each winter, when my staff and I meet with our clients to review their tax information, we get this question a lot, “Should I go with the Roth version of my employer’s 401(k) or 403(b) plan, or should I stick with the traditional version?”
Taxpayers first had the option of contributing money to a Roth account back in 1998. Remember, when you contribute money to a Roth account, you elect to forego a current year tax break in exchange for a promise from the government that distributions taken from the Roth account down the road won’t ever be taxed.
Through 2005, the only access you had to these tax-free accounts was to contribute to a Roth IRA. Many middle-income and high-income taxpayers never had the opportunity to contribute to a Roth IRA, however, since their incomes exceeded the relatively modest threshold based on their filing status. (The Roth IRA threshold for 2012 is $125k for single individuals and $183k for married couples.)
Congress liked that people were giving up a current year tax break by opting to go with a Roth IRA instead of to a Traditional IRA, so decided to expand this opportunity to 401(k) plans and 403(b) plans. As we wrote in our October 2005 Newsletter in an article called The New Roth 401k and 403b, employers could begin to offer the Roth version of these plans as of January 1, 2006.
What’s the difference between the Traditional and Roth versions of these popular retirement savings plans? With the traditional 401(k) or 403(b) plan, the salary deferrals you make reduce your taxable salary and grow tax deferred. You will then owe income taxes on distributions taken from these accounts when you retire.
Let’s say you earn $200k, and you max out your 403(b) salary deferrals for $17k during the year. In this case, your W-2 will report taxable wages of $183k in Box 1. Assuming you are in the 33% federal tax bracket, the $17k you contribute into your 403(b) plan saves you $6,667 in federal income taxes. That’s a pretty good tax break I would say.
What happens if you instead decide to go with the Roth version of the 403(b) plan for your salary deferrals? When you contribute money to a Roth account, you forego a current year tax-break. Your W-2, therefore, will report the full $200k as taxable wages in Box 1, instead of $183k that would be reported had you gone with the Traditional 403b. The benefit of giving up this tax break is the tax-free treatment of the compounded growth on the $17k of salary deferrals. In other words, you won’t owe any federal income taxes on the distributions taken from this account when you retire.
In Part 2, I’ll give you advice about the amounts you should be savings.