By Brandon Rotsky, CFP® & Wealth Advisor, SAGE Private Wealth Group
The IRS recently revised the amounts that individuals can contribute to their employer sponsored retirement plans, as well as their Health Savings Accounts (HSA’s). The proposed increases reflect a commitment to fighting inflation (curbing how much we spend) by enhancing how much we save, at a significant rate.
Wealth is a function of how much you save, rather than how much you make. With the new IRS limits on contributions to employer sponsored retirement plans and HSA’s, it’s important to recognize how much you can save into these types of accounts, and why it’s important to save into these types of accounts.
In this Financial Life Planning article, I will focus on defining the advantages of saving into an employer sponsored & Health Savings Account and the new contribution limits available for these accounts in 2023.
Employer Sponsored Plans
Most working professionals have access to an employer sponsored retirement plan, typically in the form of a 401(k) plan. A 401(k) plan is a qualified account that allows individuals to make contributions throughout the year to build a nest egg towards their retirement. Employers will often make some form of matching contributions to their employees’ 401(k) to hire and retain top talent through additional compensation.
A 401(k) is a qualified account because it qualifies for a tax advantage that typical investment accounts do not have access to. Like Individual Retirement Accounts (IRAs), a 401(k) can be either traditional or Roth based. A traditional 401(k) allows for the employee to make contributions that are pre-tax, grow tax-deferred, and taxed as ordinary income rates when withdrawn as income. A traditional 401(k) contribution is tax deductible, essentially lowering the amount of income that will be taxable in the year you made the contribution.
A Roth 401(k) allows the employee to make contributions that have already been taxed, grow tax-deferred, and be withdrawn as income tax-free. Unlike a traditional 401(k) these contributions are not tax deductible. Roth 401(k) contributions are advantageous though because once the tax is paid on the money prior to the contribution, the growth and income that results in it will not be subject to any additional taxes.
When should an employee opt for traditional contributions vs. Roth contributions? The answer depends on your current tax rate and whether you anticipate that tax rate to be higher or lower in the future. Typically, employees at the beginning of their careers tend to be in a lower tax bracket than they will be in the later stages of their career when they’ve reached peak earning potential. In this scenario, a Roth contribution would be more advantageous early on as the pre-tax benefit of a traditional contribution won’t yield as much of a benefit at a lower tax rate compared to an after-tax contribution. The inverse is also true. Traditional contributions are more advantageous later in an employee’s career as the tax-deductible nature of the contributions will have a great benefit when the employee makes a greater income and is subject to a higher tax bracket.
The major takeaway of Traditional and Roth 401(k)s:
If you anticipate being in a higher tax bracket down the road because of greater earnings potential, a Roth 401(k) tends to be preferable. If you believe you are in your peak earning years now, then a traditional 401(k) tends to be preferable.
The 2023 limit on how much an employee can make to a traditional or Roth 401(k) is $22,500. This is a $2,000 increase from 2022. An employee that is age 50 and over can contribute an additional $7,500 as a catch-up contribution. This is an increase of $1,000 from 2022.
Health Savings Accounts (HSA)
A Health Savings Account (HSA) is available to employees who are part of a high deductible insurance plan. An HSA allows employees to invest in qualified accounts that will be utilized for health-related purposes and is triple tax advantaged. An HSA combines the benefits of both a traditional and Roth contribution when utilized for healthcare related expenses. Contributions are made pre-tax, or tax deductible, like a traditional 401(k) contribution. The money then grows tax deferred. When used to pay for health-care related expenses the money is distributed tax-free, like a Roth 401(k).
An HSA will continue to grow year to year. Any balance that isn’t used for health-care related expenses will remain in the account and grow tax-deferred, unlike a Flexible Spending Account. If a Health Savings Account is not exhausted by age 65, the account will then function like a Traditional IRA, and any non-health-care related distributions will be subject to ordinary income tax.
An individual can contribute up to $3,850 per year towards an HSA in 2023, an increase of $200 from 2022. A family can contribute up to $7,750 in 2023, an increase of $450 from 2022. Catch up contributions for those 55 and older remain at $1,000.
Key Takeaway of Health Savings Accounts:
HSAs are a unique type of account due to their triple tax advantage features. HSAs allow you to participate in the benefits of investing in a traditional and Roth type of investment account, when utilized for health-care needs. If a healthcare need never presents itself, then at age 65 the account becomes an additional source of retirement savings.
With 2023 right around the corner, now is a good time to consider next year’s savings strategy into an employer sponsored retirement plan and/or a Health Savings Account. Working with a Wealth Advisor can help you determine how much of your income should be allocated to these types of accounts, and whether traditional or Roth contributions make most sense for your situation. By optimizing how you save, you are making the most of the hard-earned money you’re setting aside for your future.
Brandon Rotsky is a Wealth Advisor and CERTIFIED FINANCIAL PLANNER™ professional with SAGE Private Wealth Group. As a millennial, Brandon is passionate about empowering his peers to take ownership of their financial well-being. When he’s not cheering on the Cleveland Browns or Ohio State Football team, you can find him at a local dog park with his black-lab, Memphis.
About SAGE Private Wealth Group:
SAGE Private Wealth Group is an Investment Advisory firm located in Oakbrook Terrace, Illinois. SAGE Private Wealth Group is a team of professionals committed to making an amplified impact in the lives of our team, our clients, and our community.
Our mission is threefold:
From within, we inspire, nurture, and challenge one another to hone our gifts and uncover our passions. From there, we provide you, our client, with sage financial guidance fueled by our expertise, discipline, and conviction to do what is right. What matures is an ethical cycle that empowers women and children through education and access to capital.
Our passion is rooted in supporting our team, who then takes care of our clients. Together, we serve our community.
Our team of dedicated CERTIFIED FINANCIAL PLANNER™ (CFP®) professionals work with our clients to manage and preserve their wealth while helping them build their financial legacies.
Sources: https://www.irs.gov/newsroom/401k-limit-increases-to-22500-for-2023-ira-limit-rises-to-6500 https://www.shrm.org/resourcesandtools/hr-topics/benefits/pages/2023-irs-contribution-limits-for-hsas-and-high-deductibel-health-plans.aspx