Want to lower next year’s tax bill? Boost your 401(k) contributions

Whether you got a refund or owed money this tax season, it’s never too soon to start thinking about next year’s bill.

Boosting your 401(k) contributions for 2022 may provide two benefits: reducing your adjusted gross income while also padding your retirement savings.

What’s more, there’s a higher 401(k) employee deferral limit for 2022, offering a bigger write-off to set aside money for your golden years.

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Employees may funnel $20,500 into 401(k), 403(b) and similar plans for 2022, up from $19,500 in 2021, thanks to cost-of-living adjustments from the IRS, and investors 50 and older may add $6,500 for catch-up contributions.

“You’re smart to jump on this,” said certified financial planner Catherine Valega, wealth consultant at Green Bee Advisory in Winchester, Massachusetts. “Most people set [401(k) contributions] once and never look back.”

If you aim to max out 401(k) contributions for 2022, it may pay off to start early, as spreading it out may be more manageable than year-end increases.

The sooner you can increase your contributions, the sooner you can have your money working for you.

Margherita Cheng

CEO and co-founder of Blue Ocean Global Wealth

And more time in the market may offer more growth potential, said Washington-based CFP Marguerita Cheng, CEO and co-founder of Blue Ocean Global Wealth in Gaithersburg, Maryland, and a member of CNBC’s Advisor Council.

“The sooner you can increase your contributions, the sooner you can have your money working for you,” she said.

Max out your 401(k) early

Higher earners may also consider front-loading 401(k) contributions to reach the deferral limit before year-end.

For example, if you receive an October bonus, you may front-load 401(k) contributions to max out the plan, freeing up more take-home pay for November and December.

Before maxing out the plan early, however, you need to know how your 401(k) match works, Valega said. Many companies only kick in matching funds when you defer part of your paycheck.

In that case, you won’t receive the full employer match unless you make 401(k) contributions every pay period.

However, other plans have what’s known as a “true-up,” meaning the company calculates the 401(k) match on an annual basis rather than every pay period.

“It means they don’t really care when you put in your money,” said Valega. “They will make sure that you get the full match at the end of the year.”

You can learn more about your match by checking your 401(k) summary plan description, which covers how the account works or reviewing the document with a financial advisor.

Downsides of maxing out your 401(k)

While maxing out 401(k) contributions is a lofty goal, there are reasons why you may decide to limit deferrals after receiving the full company match.

“This, of course, may vary depending on goals,” said Marianela Collado, a CFP and CPA at Tobias Financial Advisors in Plantation, Florida.

For example, if you’re saving a down payment for a home, you may decide to re-route funds until meeting your short-term goal, she said.

Likewise, if you’re sitting on high-interest credit card debt or don’t have an emergency fund, you may allocate money elsewhere before increasing 401(k) deferrals.

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