Making a retirement contribution on Dec. 31, 2022 vs. Jan. 1, 2023 probably doesn't seem like a big deal to you, but it makes an enormous difference to the government. And since no one wants to give the IRS a reason to knock at their door, it's important to understand the implications of your decision.
Below, we'll take a look at the reasons to make a contribution now versus waiting until the new year to help you decide what's best for you.
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Reasons to make a 2022 retirement contribution
Contributions to tax-deferred retirement accounts, like traditional IRAs and 401(k)s, reduce your taxable income for the year. For example, if you earn $60,000 this year and put $5,000 in a traditional IRA, the government only taxes you on the remaining $55,000 for 2022. You'll pay taxes on your traditional IRA funds when you withdraw the money later.
It's sometimes possible to drop into a lower tax bracket using one of these accounts, depending on your income and how much you contribute. So it could be worth making a quick contribution now if you'd like to reduce your tax bill for 2022.
You won't get a tax break if you put money in a Roth retirement account because this account gives you tax-free withdrawals in retirement. But if you're opening a Roth account for the first time, there may still be an advantage to doing it now.
Roth IRAs have a five-year rule, which says you can't withdraw your earnings tax-free until you've had your Roth account for at least five years. But the clock starts on Jan. 1 of the year you open the account. So if you open one now, your five-year clock begins on Jan. 1, 2022 instead of Jan. 1, 2023.
And no matter which type of retirement account you use, a 2022 contribution will be invested for longer than a 2023 contribution before you need to withdraw it. And this means it has more time to grow and will likely be worth more in the end.
Reasons to make a 2023 retirement contribution
If you don't have any spare cash right now to make a 2022 retirement contribution, you may have to set your sights on 2023 if you'd like to save even more. But that's not the only reason you may want to hold off on your retirement contributions.
Retirement accounts have annual contribution limits. In 2022, you can only contribute $19,500 to a 401(k) and $6,000 to an IRA. Adults 50 and older can contribute up to $26,000 to a 401(k) and $7,000 to an IRA. If you've already hit these limits for the year, then putting more money in your retirement accounts in 2022 is just going to cause you to incur costly penalties. So you're better off waiting for next year.
You could make a prior-year retirement contribution if you change your mind
You must make 401(k) contributions by Dec. 31, but the deadline for 2022 IRA contributions is actually April 18, 2023. However, things get a little more complicated if you wait until 2023 to make a contribution for 2022.
Many IRA providers automatically assume your contributions are for the tax year in which they're made unless you specify that you'd like to make a prior-year contribution. You may want to follow up to ensure your contribution is applied to the correct tax year.
You also want to make any prior-year contributions before you file your 2022 tax return. While you can technically do so after, you'll have to file an amended return, and no one wants to do their taxes twice.
In a perfect world, you'd be able to make a 2022 contribution now and set aside money in 2023. But when spare cash is in short supply, you have to weigh your options. Consider the information above and time your contributions based on what you think is best for you.
