Planning for retirement often involves making contributions to tax-advantaged accounts like 401(k)s and IRAs. These accounts offer attractive tax benefits, but staying within the IRS-imposed limits is essential. Exceeding these limits can result in unwanted tax consequences. Here’s what you need to know about excess contributions and how to rectify them before the tax deadline.
For the 2023 tax year, the contribution limits for retirement accounts vary based on age and the type of account being used. For those under 50, they can contribute $22,500 to their 401(k) and $6,500 to their IRA. For those aged 50 or older, the limits increase to $30,000 for a 401(k) and $7,500 for an IRA.
It’s crucial to understand that when calculating your annual 401(k) contributions, only the amount set aside by you, not employer-matched funds, counts towards the limit. Additionally, if you have multiple retirement accounts, like a traditional and a Roth IRA or a traditional and a Roth 401(k), the contribution limits apply to the total amount contributed to each type of account. As such, it’s not possible to contribute $6,500 to both a traditional IRA and a Roth IRA or $22,500 each to a traditional 401(k) and a Roth 401(k).
High earners interested in contributing to a Roth IRA should also be aware of income limits that can reduce or eliminate the ability to make direct contributions. These limits aim to prevent individuals with six-figure incomes from overcontributing to their Roth IRAs inadvertently.
To avoid the potential tax headache of excess contributions, it’s crucial to carefully monitor your contributions throughout the year and ensure they fall within the prescribed limits. If you do contribute more than allowed, there are remedies available. One option is to withdraw the excess amount before the tax filing deadline, including any associated earnings. One option is to carry forward the excess contribution to the following tax year, but this may result in additional taxes.
Remember, staying informed about retirement account contribution limits and understanding the rules is vital to avoid unnecessary tax issues. Keep track of your contributions, consult a financial advisor if needed, and stay within the prescribed limits to enjoy the tax advantages offered by retirement accounts.