Offset Inflation with Increased Retirement Contributions
The IRS has raised the contribution limits for 401(k) plans for 2023
With inflation clocking in at 8.2% over the past year, multiple government agencies are implementing changes to benefits and limits to accommodate the higher cost of living. For example, the Social Security Administration recently announced a 8.7% cost-of-living adjustment for retirees in 2023.
We will look at the 2023 changes to the 401(k) limits recently made by the IRS and whether you should change your savings strategies in response.
401(k) Contribution Changes
For 2023, the annual individual contribution limit for 401(k) plans is $22,500, up from $20,500 in 2022. That is the maximum you can defer from your gross W-2 wage in either a traditional (pre-tax), ROTH (post-tax) or blended method. Of course, your practice will make a matching contribution as well.
If you are over the distinguished age of 50 you are also eligible for catch-up contributions to the practice 401(k) plan from your gross W-2 wage. This means that you can contribute an additional to $7,500 as a “catch-up” contribution in 2023. In total, individuals over the age of 50 can contribute up to $30,000 to their 401(k).
If practice and personal cash flow allow, we ALWAYS recommend maximizing your 401(k) contribution. Even in the currently volatile stock market, you do not want to stop contributing to your 401(k). If you are nervous about your returns, you should continue to maximize contributions while reviewing the investment allocations of your retirement funds.
Defined Contribution Limit Changes
If you truly want to maximize your 401(k), you need to take advantage of the Profit Sharing component of your plan. Once you have added a Profit Share option to your 401(k) plan, you can put away significant amounts of cash into your retirement savings (as well as increase your tax deductions). For 2023, the maximum defined contribution into this combination is $66,000 for those under 50 and $73,500 for those over 50.
If your practice has profits of over $350,000/year, you should seriously consider the 401(k) profit sharing for the tax savings alone.
If you are in your 40s and got a late start with your retirement savings, maximizing this option is a great way to get back on track.
401(k) Compensation Limit
To get the most out of the practice match and get the optimal allocation of profit sharing between yourself and your team, you will want to increase your W-2 wage for 2023 to the new limit of $330,000. This means the practice will contribute a percentage match of that higher salary to your plan. If you plan has the standard 4% match, that is an additional $13,200 that the practice contributes on top of your W-2 contribution (above).
If your practice is generating over $2mil in collections, you will want to look at this option to maximize your 401(k) benefits and tax planning options.
Defined Benefit Limit Changes
The opposite of a Defined Contribution Plan (like a 401(k)) is the Defined Benefit Plan (DBP). A DBP (like a Cash Balance plan) is similar to a government pension plan in that it promises a certain payment in retirement. To guarantee that amount is there in retirement, these plans have mandatory contribution periods and large annual payment requirements. For 2023, the new maximum annual benefit amount has increased to $265,000 so the opportunity to increase funding to a cash balance plan will increase as well.
If:
-> your debt is paid off
-> your practice is collecting over $2.5mil
-> you have maximized the 401(k) options above
-> and you still have cash available…
You should look into a cash balance plan for your practice if you anticipate continued $1mil profitability for the next five years and want to reach financial freedom (the ability to make work optional) in the next ten years.