As time moves on, it's easy to think that the rules around IRAs, or individual retirement accounts, stay the same. However, there are often changes to retirement account rules that can meaningfully impact your ability to maximize your long-term wealth. Staying on top of these rule changes -- as well as current events in the macroeconomic environment -- is key to a sustainable financial plan.
Below, I'll list three major mistakes investors are liable to make in 2023 and provide some guidance on how to avoid them.
1. Ignore the contribution limit increase
In 2023, your total annual IRA contribution limit will increase from $6,000 to $6,500, the first such change since 2018. If you're over 50, you'll be able to contribute $7,500 through an additional $1,000 catch-up contribution. It may not seem like much, but it's an opportunity to further expand your tax-advantaged investment space, which, as you may know, is already quite limited.
The $6,500 annual contribution is a total number, meant to include contributions to both Roth and traditional IRAs. This number doesn't include 401(k) rollovers to IRAs, which are not considered contributions in the first place. Remember that this is $6,500 per individual, so if you're married, the two of you will be able to contribute a total of $13,000 ($15,000 if you're both over 50) to Roth and/or traditional IRAs.
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2. Contribute directly to a Roth IRA if you're a high earner
If you're single and earn more than $138,000 ($218,000 if you're married) in 2023, you won't be able to make a full direct contribution to a Roth IRA. Those with incomes over $153,000 for singles and $228,000 for joint filers won't be able to contribute directly to a Roth at all. If you do make a direct Roth contribution, you'll be left with what's called "excess" Roth contributions -- these must be removed by the tax filing deadline in 2024. For every year you neglect to fix your excess Roth contributions, the IRS will levy a 6% excise tax on the excess contributions and related earnings.
If you're not sure about your income for 2023, or if you think you'll be on the border of the income limit, it's a good idea to look into a potential backdoor Roth contribution. Note that if you are also above income limits for deducting a contribution to a traditional IRA and you have other pre-tax traditional IRA balances, you could potentially run into some tax trouble via the pro-rata rule. Those in that situation might consider a non-deductible traditional IRA instead of a Roth.
3. Miss the opportunity for Roth conversions
The stock market's decline has been unfortunate for most people nearing retirement, but it has also created an opportunity for the tax-savvy. The moment is ripe for those in lower-than-average income years, like the years between retirement from a formal career and the start of Social Security, to think about moving money to Roth status.
If you have money sitting in traditional IRAs or even pre-tax 401(k)s, the decrease in stock valuations is a chance for you to convert money from these pre-tax accounts to Roth accounts at potentially lower tax rates. When the stock market recovers, as it always has, your money will be tax-free forever. Not a bad consolation prize for enduring a bad market decline.
Know the common errors to avoid them
When it comes to sound financial planning, the key is to get the basics right and let the rest pan out as it will. If you're aware of the common mistakes around IRAs in pre-retirement, you're less likely to fall prey to them. The stock market's performance in 2022 is not necessarily an indicator of what may lie ahead; be sure to use the best available information to make any key decisions about your future.
Editor's note: A previous version of this article failed to note the interaction of income limits on Roth contributions and on deductibility for traditional IRA contributions. The Fool and the author regret the error.
