Retirement savings accounts like a 401(k), 403(b), Thrift Savings Plan, and others have a “use it or lose it” aspect when it comes to contributions.
Each year, there is a limit on how much you can contribute; and if don’t utilize the full contribution amount for the year, you can’t make up those missed contributions in later years.
Working with first-year attending physicians, many are in a unique spot of a partial year of higher income, and an opportunity to utilize a full year of contributions, if cash flow allows. Here are two strong reasons on why to take advantage of the full amount in your first partial year of attending:
1. Time value of money; contributing $20,500 in 2022, if this is your first year as a physician in your young 30s, can grow significantly over your career thanks to time.
2. The markets have depressed over 20% this year which allows for you to buy into lower prices; this, along with point #1, is a great way to jump start compounding growth.
There are many reasons to contribute to retirement accounts, largely tax benefits and asset protection, but this blog is focused on the contribution rules of retirement accounts.
Main retirement account
If you’re an employee, the most common retirement accounts include a 401(k), 403(b) and the Thrift Savings Plan for government employees.
These plans all have the same employee contribution limits, which change each year with inflation adjustments; the current limit in 2022 is $20,500 for those under 50 years old.
This $20,500 is the total for an employee over a calendar year, no matter how many employers you had in that year. If you contributed $3k during residency to get a match, then you can only contribute $17,500 during your attending position in the same year.
Your employer can contribute above and beyond that limit for you if they choose – the $20,500 is for your employee contributions. The total annual contribution limit into one of these accounts for those under 50 is $61,000; therefore, if you max out your employee contribution, the maximum employer contribution is $40,500.
The $40,500 limit is for each employer – whereas your individual amount is your personal total for the full year among all jobs. So, if you worked for multiple employers, and they both had very generous contributions, you could get more than the $61k total by receiving employer contributions from both employers and by making total employee contributions of $20,500.
Finally, there are certain plans that allow for employee contributions beyond the $20,500 but must stay within the total limits of $61k total contributions; these are called after-tax contributions and are typically utilized in a mega back-door Roth strategy. This strategy is beyond the scope of this blog.
Additional retirement accounts
There are many other retirement accounts with which contributions may or may not be included in the employee $20,500. Here are some rules around some of these accounts:
457(b) – these are delineated between governmental and non-governmental accounts. But either way, these accounts have the same contribution limits as the standard retirement accounts and can be used WITH the other retirement accounts. So, you get an employee $20,500 limit for EACH the 457(b) and your other retirement plan. If your 457(b) is a non-governmental plan, then it doesn’t operate the same as a qualified retirement plan, which should be considered before utilizing it.
401(a) – there are a few different types of 401(a) accounts. Sometimes they have voluntary contributions, and sometimes they have mandatory contributions. But due to the rules of the 401(a) plan, your contributions typically do not count towards your employee $20,500 limit with other plans. If you were forced to contribute to your 401(a) during residency, you can likely still do the full contribution to your 401(k) when you start attending.
Defined benefit – If you have a defined benefit plan at work, also called a pension, like the FERS pension through the government or other state-run pension plans, these contributions do not count towards the employee $20,500 limit. For example, you can be part of the FERS system and still max out your Thrift Savings Plan at $20,500 this year. If your job that offers a pension does not have a different retirement plan for your contributions, those pension contributions do not count towards the employee limits if you get a new job in the same year.
SEP IRA – I don’t see these too often, but these are an employer funded account. You can’t make any contributions as an employee, so if you have one of them and leave, your employee $20,500 limit should be unaffected.
Self-employed retirement accounts
If you’re self-employed, things typically get a bit more complicated. You don’t have somebody setting up and administering the account, you have a bit more work to choose the account, set it up, fund it and manage it, among other responsibilities.
But these accounts follow the same contribution limits. If you set up a solo-401(k), you have the same $20,500 contribution limit as an “employee” and the total $61k among employee and employer (even if you are both of those roles).
If you set up two businesses; you don’t get to do this twice. You would be considered a control group by owning both businesses and the IRS sees that as one opportunity for the retirement plan contribution limits. So if you are fully self-employed and own 50 different business, you can only contribute a total of $61k among all those businesses.
But, if you work for a hospital and get 401(k) contributions from them, as well as being self-employed, you can use that self-employment income to further fund a self-employed retirement account to the full $61,000 if your income allows for it. This can be on top of any contributions the hospital would make for you, so you could potentially go beyond the $61k limit in one year.
Self-employed retirement accounts are limited to both total contribution limits of $61,000, as well as contribution limits based on your income. Due to a contribution calculation, if your business makes $65k, you’re not going to be able to put the full $61k into a retirement account, even if you don't need the money.
There are a few other self-employed retirement plans like a SEP IRA and a Simple IRA, which each have their own contribution rules, neither of which exceed the $61k total limit.
Individual retirement accounts – technically individual retirement arrangements or IRAs
Beyond company-sponsored / self-employed sponsored retirement accounts, everybody has access to individual retirement accounts, including a Traditional IRA and a Roth IRA.
Everybody can contribute to these each year up to a total of $6k if you’re under 50, whether you contribute to other retirement plans or not. The total $6k is among both Roth and Traditional; not $6k each. The $20,500 employee limit is a separate contribution limit from the $6k contribution limit. If you max fund your 401(k) and IRA, you contributed a total of $26,500 into your retirement accounts, which is allowed.
There are income limits to the Roth IRA, so if you are above those limits then your only option to contribute your $6k is through a Traditional IRA.
There are also income limits to a Traditional IRA depending on your access (or your spouse’s access) to other retirement accounts. The income limits on the Traditional IRA do not determine if you can contribute to the account; anybody can contribute to the Traditional IRA regardless of income. The income limits are if the IRS will allow you to claim a deduction on your tax return for those contributions.
Many high-income professionals make too much money to deduct these contributions, and immediately convert them to their Roth IRA. This is known as the back-door Roth IRA strategy. Make you sure you follow all the rules and report this correctly on your tax return.
Rollovers
Finally, I want to emphasize that all this information is based on contributions. There are no limits to the size of these retirement accounts. Peter Thiel proved this through his $5bn Roth IRA.
The limits are on contributions that are allowed each year, not how much these accounts can grow. One reason I point this out is the fact of rollovers. If you’re leaving jobs and want to keep your money in qualified retirement plans, you can always roll them over into a new plan or an IRA without affecting your contributions for that year.
If you rollover $10k into an IRA, that does not count towards your $6k annual contribution. These are two separate items, and your contribution limit remains available to you regardless of rollovers.
Final Thoughts
The “use it or lose it” aspect to retirement contributions bring a unique opportunity for those on the cusp of a high income if they are able to utilize a partial year of high income to get the full contribution limit.
This will help to jump-start the funding of your retirement, and you won’t regret missing out on it in the next year when you’ll likely be able to comfortably max out your 401(k) and have more to save.
Understanding the rules and how much you can contribute can bring opportunity in the form of tax advantages and time for the money to grow.
On the flip side, not understanding the rules and overcontributing to these accounts can bring some headaches, expenses and penalties come tax time.