This is the time of year when we look for tax deductions and plan for next year. Planning our IRA and Solo 401(k) is part of the process. Remember your Solo 401(k) plan must be set up by December 31^st to make 2022 contributions, whereas, your IRA can be set up the day taxes are due in 2023.

For 2023, the total contributions you make each year to all of your traditional IRAs  and Roth IRAs can’t be more than:

• $6,500 ($7,500 if you’re age 50 or older), or
• If less, your taxable compensation for the year

For 2022, 2021, 2020 and 2019, the total contributions you make each year to all of your traditional IRAs  and Roth IRAs can’t be more than:

• $6,000 ($7,000 if you’re age 50 or older), or
• If less, your taxable compensation for the year

The IRA contribution limit does not apply to:

• Rollover contributions
• Qualified reservist repayments

Deducting your IRA contribution

Your traditional IRA contributions may be tax-deductible. The deduction may be limited if you or your spouse is covered by a retirement plan at work and your income exceeds certain levels.

• IRA deduction limits

Roth IRA contribution limit

In addition to the general contribution limit that applies to both Roth and traditional IRAs, your Roth IRA contribution may be limited based on your filing status and income.

• 2023 – Amount of Roth IRA Contributions You Can Make for 2023
• 2022 – Amount of Roth IRA Contributions You Can Make for 2022

IRA contributions after age 70½

For 2020 and later, there is no age limit on making regular contributions to traditional or Roth IRAs.

For 2019, if you’re 70 ½ or older, you can’t make a regular contribution to a traditional IRA. However, you can still contribute to a Roth IRA and make rollover contributions to a Roth or traditional IRA regardless of your age.

Spousal IRAs

If you file a joint return, you may be able to contribute to an IRA even if you didn’t have taxable compensation as long as your spouse did. Each spouse can make a contribution up to the current limit; however, the total of your combined contributions can’t be more than the taxable compensation reported on your joint return. See the Kay Bailey Hutchison Spousal IRA Limit in Publication 590-A.

If neither spouse participated in a retirement plan at work, all of your contributions will be deductible.

Can I contribute to an IRA if I participate in a retirement plan at work?

You can contribute to a traditional or Roth IRA even if you participate in another retirement plan through your employer or business. However, you may not be able to deduct all of your traditional IRA contributions if you or your spouse participates in another retirement plan at work. Roth IRA contributions might be limited if your income exceeds a certain level.

Examples

1. Danny, an unmarried college student earned $3,500 in 2020. Danny can contribute $3,500, the amount of his compensation, to his IRA for 2020. Danny’s grandmother can make the contribution on his behalf.
2. John, age 42, has a traditional IRA and a Roth IRA. He can contribute a total of $6,000 to either one or both for 2020.
3. Sarah, age 50, is married with no taxable compensation for 2020. She and her spouse, age 48, reported taxable compensation of $60,000 on their 2020 joint return. Sarah may contribute $7,000 to her IRA for 2020 ($6,000 plus an additional $1,000 contribution for age 50 and over). Her spouse may also contribute $6,000 to an IRA for 2020.

Tax on excess IRA contributions

An excess IRA contribution occurs if you:

• Contribute more than the contribution limit.
• Make a regular IRA contribution for 2019, or earlier, to a traditional IRA at age 70½ or older.
• Make an improper rollover contribution to an IRA.

Excess contributions are taxed at 6% per year for each year the excess amounts remain in the IRA. The tax can’t be more than 6% of the combined value of all your IRAs as of the end of the tax year.

To avoid the 6% tax on excess contributions, you must withdraw:

• the excess contributions from your IRA by the due date of your individual income tax return (including extensions); and
• any income earned on the excess contribution.

See Publication 590-A for certain conditions that may allow you to avoid including withdrawals of excess contributions in your

Solo 401(k) contribution limits

The total solo 401(k) contribution limit is up to $61,000 in 2022 and $66,000 in 2023. There is a catch-up contribution of an extra $6,500 for those 50 or older in 2022 and $7,500 in 2023.

To understand solo 401(k) contribution rules, you want to think of yourself as two people: an employer (of yourself) and an employee (yes, also of yourself). Within that overall $61,000 contribution limit in 2022 and $66,000 in 2023, your contributions are subject to additional limits in each role:

• As the employee, you can contribute up to $20,500 in 2022, $22,500 in 2023, or 100% of compensation, whichever is less. Those 50 or older get to contribute an additional $6,500 here in 2022 and $7,500 in 2023.
• As the employer, you can make an additional profit-sharing contribution of up to 25% of your compensation or net self-employment income, which is your net profit less half your self-employment tax and the plan contributions you made for yourself. The limit on compensation that can be used to factor your contribution is $305,000 in 2022 and $330,000 in 2023

Keep in mind that if you’re side-gigging, employee 401(k) limits apply by person, rather than by plan. That means if you’re also participating in a 401(k) at your day job, the limit applies to contributions across all plans, not each individual plan.

Is Solo 401(k) tax deductible? Solo 401(k) tax advantages

The nice thing about a solo 401(k) is you get to pick your tax advantage: You can opt for the traditional 401(k), under which contributions reduce your income in the year they are made. In that case, distributions in retirement will be taxed as ordinary income. The alternative is the Roth solo 401(k), which offers no initial tax break but allows you to take distributions in retirement tax-free.

In general, a Roth is a better option if you expect your income to be higher in retirement. If you think your income will go down in retirement, opt for the tax break today with a traditional 401(k).

Because of these tax perks, the IRS has pretty strict rules about when you can tap the money you put into either type of account: With few exceptions, you’ll pay taxes and penalties on any distributions before age 59 ½.

 Covering your spouse under your solo 401(k)

The IRS allows one exception to the no-employees rule on the solo 401(k): Your spouse, if he or she earns income from your business.

That could effectively double the amount you can contribute as a family, depending on your income. Your spouse would make elective deferrals as your employee, up to the $19,500 employee contribution limit (plus the 50-and-older catch-up provision, if applicable). As the employer, you can then make the plan’s profit-sharing contribution for your spouse, of up to 25% of compensation.

As we always say, plan with your financial advisor or accountant when to contribute and how much to take advantage of the maximum tax savings and growth potential.

Information from IRS.gov