From The McGill Advisory, January 2022
Here are six steps to take immediately, so that you can enjoy the full advantage of the increased contributions available for 2022.
Fund Increased HSA Contributions
If you’re covered by a high-deductible health plan (HDHP) as we recommend, you’re eligible for tax-deductible HSA contributions. Make the maximum 2022 contribution now, which has been increased from $3,600 in 2021 to $3,650 in 2022, if single, or from $7,200 in 2021 to $7,300 in 2022 for family, and be sure to add the extra $1,000 catch-up contribution for each spouse age 55 or older. Note that HSA contributions generally must end once you reach age 65.
While Americans have over $82 billion stashed in HSA accounts, unfortunately 93% of these funds are sitting in no-interest checking accounts. We recommend investing your HSA funds so you can accumulate up to $560,000 in extra earnings, which can be withdrawn tax-free later to the extent of your qualified medical expenses. That’s important since Fidelity estimates that you’ll spend close to $250,000 on medical care in retirement. The top places to invest your HSA funds are Lively (www. livelyme.com) and Fidelity (www.fidelity.com) since they charge low expenses and offer a variety of solid low-cost investment options.
Fund IRA Contributions
If your income exceeds $144,000 (single) or $214,000 (married), you’re not eligible to contribute directly to a Roth IRA. However, as long as you have earned income you can qualify for a regular, non-deductible IRA contribution of $6,000 per spouse, or $7,000 for each spouse age 50 or older. So, contribute now to maximize your earnings, which can grow tax-deferred and are protected from the 3.8% Affordable Care Act (ACA) tax.
Convert Regular IRAs into Roth IRAs
If you’re like most doctors, your income is too high to contribute directly to a Roth IRA as discussed above. However, you can legally convert all or part of your regular IRA into a Roth IRA to enjoy future tax-free growth. To avoid taxes on your Roth conversion, make sure your investment advisor has rolled all of your taxable IRA funds into your 401(k) or other retirement plan first. If your advisor hasn’t done this, or doesn’t know how, find one that can. But you need to act quickly since pending legislation would eliminate future tax-free Roth IRA conversions.
Fund Your 401(k) Salary Deferrals
The maximum tax-deductible 401(k) salary deferral amount has been increased to $20,500 for 2022 and $27,000 for those age 50 or older. So, go ahead and divide the maximum contribution amount by the number of your pay periods in 2022 and start deducting those salary deferrals, beginning with your first paycheck. Married? If so, make sure your spouse is employed either through the practice or elsewhere, so that he/she can also make the maximum tax-deductible 401(k) salary deferral, doubling your family’s tax-deductible benefit.
Increase Your Auto Draft for Practice Retirement Plan Contributions
You need to estimate the practice-related contributions necessary for you to receive the maximum retirement plan contribution for 2022, which has been increased for defined contribution plans such as 401(k) plans to $61,000 if under 50, and $67,500 if 50 or older. Then, divide this amount into monthly payments to be automatically drafted from your practice checking account for immediate investment.
Why do we recommend this automatic investment program? It’s simple! The 90% of our clients who save automatically have accumulated more than twice the amount of the 10% who don’t, despite their income levels being virtually the same. The reality is saving by automatic draft ensures that your savings happen, increases your potential return through dollar-cost averaging, and helps you avoid emotional investing (buying high and selling low).
Optimize Your Salary to Maximize Retirement Plan Efficiency
Retirement plan contributions are based on your salary, so it’s important to set it at its optimal level. The maximum salary that can be considered for retirement plan contributions has been increased from $290,000 in 2021 to $305,000 in 2022. There’s no benefit in taking a higher salary than this, since it only leads to increased income and payroll taxes and decreases the potential practice profits eligible for dividend distributions and the 20% practice profits deduction allowed under Section 199A.
Taking a salary below $305,000 could boost your Section 199A deduction (if eligible), but any tax savings may be wiped out by retirement contributions that are lower for you and higher for your staff. So, make sure your retirement plan advisor calculates the optimum salary you should take in order to gain the best economic advantage.
Why hassle with beginning-of-the-year funding rather than waiting until year-end to make the contributions? Assume a 40-year-old doctor makes the maximum 401(k) plan contribution (including salary deferral, matching, and profit-sharing) for their self ($61,000) and maximum salary deferral for their spouse ($20,500); the maximum HSA family contribution of $7,300; and IRA contributions of $6,000 for each spouse ($12,000 total), for total 2022 savings of $100,800. Investing these funds at the beginning of the year at a 6% return would result in accumulating $8,447,209 over 30 years, versus $7,969,065 if funded at year-end. That’s an extra $478,144 in retirement savings by funding early—way too much "free" money to pass up!
The above article was reprinted with permission from The McGill Advisory, a monthly newsletter with online resources devoted to tax, financial planning, investments, and practice management matters exclusively for dentists and specialists, published by John K. McGill & Company, Inc. (a member of The McGill & Hill Group LLC). Visit www.mcgilladvisory.com or call 888.249.7537 for further information. John K. McGill, Publisher - The McGill Advisory