Roth IRA Changes Are Coming in 2022: 10 Moves to Make

New year, new Roth IRA rules. In 2022, the income limits that apply to contributions are increasing.

The Roth IRA is a powerful retirement savings resource. Although you contribute to one with after-tax money, the earnings are tax-deferred and qualified retirement withdrawals are tax-free. The account also offers some withdrawal flexibility. Unlike a 401(k) or traditional IRA, you can withdraw your Roth IRA contributions, but not earnings, at any time without penalty.

Read on for details on the 2022 Roth IRA changes and a step-by-step plan to see if you can benefit from those updates.

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The Roth IRA income limits have three tiers, all expressed in terms of modified adjusted gross income (MAGI). If you don't know your MAGI, you can't determine precisely how the Roth IRA income limits apply to you.

To start, find your adjusted gross income (AGI) on your last tax return. This is your gross income less a few tax-deductible expenses. To get from AGI to MAGI, you must add back certain deductions, including deductions taken for student loan interest and IRA contributions. The IRS worksheet here outlines the full calculation. Some of these deductions are rare, so your AGI and MAGI could be the same number.

Since you'll be working from 2020 numbers, remember to estimate any income changes since then for planning your 2022 retirement contributions.

Below are the 2022 income limits for Roth IRA contributions, based on your tax filing status.

If you are a single filer or head of household:

• With a MAGI of less than $129,000, you can make a full contribution.
• With a MAGI of $129,000 or more, but less than $144,000, you can make a reduced contribution.
• With a MAGI of $144,000 or more, you cannot make a Roth contribution.

If you are married and file jointly:

• If you make less than $204,000, you can make a full contribution.
• If you make $204,000 or more, but less than $214,000, you can make a reduced contribution.
• If you make $214,000 or more, you cannot make a Roth contribution.

In 2022, the full Roth IRA contribution is $6,000, or $7,000 if you're 50 or older. If your MAGI falls in the "reduced contribution" category, you must calculate your allowed contribution. You can find the worksheet for this in IRS publication 590-A -- but you may want to enlist the help of tax software or an advisor to do the math for you.

ALSO READ: What Modified Adjusted Income Is and Why It's Important

Estimating your retirement income helps you understand if Roth IRA contributions make sense for you. In a Roth IRA, you are essentially prepaying income taxes on your retirement savings. That's a good deal if your income tax rate today is lower than it will be in retirement. After all, why pay more later when you can pay less now?

If you expect your income to be lower in retirement, the traditional IRA may be a better place to save. The traditional IRA gives you a tax deduction in the current year on your contribution. You still get tax-deferred earnings, but your withdrawals in retirement are taxed as ordinary income.

You can estimate your retirement income if you have a realistic target savings goal. First, calculate 4% of your savings goal. That's roughly the annual income that a retirement portfolio can support for 30 to 40 years. Add that number to your estimated Social Security benefit, which you can find at my Social Security. Also add any other sources of income you expect. The total is your projected retirement income.

Budgeting should be a regular year-end activity, whether you're planning on Roth IRA contributions or not. A good budget defines your spending across all categories, including your retirement contributions.

To start, subtract your target retirement contribution from your net income. What's left is the funds available to pay your bills. From there, subtract your nonnegotiable expenses -- rent, utilities, groceries, and debt repayments. That leaves you with your entertainment and shopping budget.

With a balanced budget, you can feel confident your target retirement contribution is realistic. All you must do is comply with your own spending limits. Use an app, a notepad, or a spreadsheet to stay organized and in touch with your cash outlays.

ALSO READ: How to Start Budgeting for the First Time

You may have multiple options for retirement savings accounts. If you do, you'll need to split your contribution budget up across those accounts.

Many savers benefit from prioritizing their available retirement contributions this way:

1. First, make 401(k) contributions that max out employer matching contributions.
2. Then, contribute to your health savings account (HSA) if you are eligible.
3. If you still have budgeted contributions available, send them to your Roth or traditional IRA, depending on your tax needs.
4. Any remaining funds can go into your 401(k) up to the limit.

401(k) contributions are usually higher priority than Roth IRA contributions, assuming you qualify for free employer match. Those free contributions can be worth hundreds of thousands to you over time. HSAs are appealing because they offer tax-free contributions, tax-deferred earnings, and tax-free withdrawals for medical expenses.

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As noted, you can withdraw your Roth IRA contributions without penalty -- but that's usually not a great idea. Unless you've decided to use your Roth savings for something other than retirement, it's best to keep your money invested in the account.

A solid emergency fund can make that possible. With a nice cash balance on hand, you can use those funds for financial surprises, instead of tapping your Roth.

Experts recommend a cash balance that's enough to cover six months of living expenses. If you don't have that today, revisit your budget. Allocate a monthly deposit to your cash savings account and start building that balance.

It's smart to check your retirement savings progress annually using a compound interest calculator like this one. Doing so will also validate that your budgeted retirement contributions are sufficient to support your savings goal.

A compound interest calculator will ask you to estimate your annual interest rate. If your retirement savings are mostly invested in equities, use 7%. This is the long-term average annual growth of the stock market. It's an appropriate number for projections, as long as your timeline is 10 years or more.

You might be tempted to use a higher growth rate, particularly if your account has performed well over the past few years. Resist that temptation. The stock market grew at above-average rates in 2019 and 2020. Growth above the 7% average happens, but it's not sustainable long term.

ALSO READ: Average Stock Market Return

Asset allocation is your portfolio's composition across different asset types, like stocks and bonds. This composition is important because it influences how risky or stable your portfolio is.

The rule of 110 can provide guidance on an appropriate portfolio composition based on your age. The thinking is that you can tolerate more risk when you're younger, because you don't need the money right away. To use the rule, subtract your age from 110. The answer is the percentage of your portfolio that should be invested in stocks.

At age 25, for example, the rule of 110 recommends a portfolio that's 85% stocks and 15% bonds. At age 45, you'd have a more conservative asset allocation of 65% stocks and 35% bonds.

If you're certain you are eligible for Roth IRA contributions in 2022, it's smart to automate your contributions and investments. Time the contribution to transfer from your checking account on payday, and you might not even miss the funds. And if your Roth IRA custodian allows for automatic investments, you can put your portfolio on autopilot.

Studies show that people save more when their retirement account is automated. As an example, a 2021 Vanguard report concludes that savings rates in automatic enrollment 401(k)s are 57% higher versus voluntary plans.

If you contribute too much to your Roth IRA, the IRS will charge a 6% penalty each year until you fix the mistake. Fixing the mistake involves withdrawing the excess contributions and any associated earnings. Note that withdrawing earnings may trigger taxes and a 10% penalty unless you qualify for an exception.

To minimize the IRS charges, correct the overcontribution as soon as you realize it's happened. If you see the mistake before filing your next tax return, withdraw the excess funds right away to sidestep all taxes and penalties. Otherwise, you can withdraw the excess funds and file an amended return by the October extension deadline.

If the extension deadline passes, you'll owe the 6% penalty for that year and every year until you correct the overcontribution.

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2022 will usher in new, higher income limits on Roth IRA contributions. As 2021 ends, think through how -- or if -- a Roth IRA fits into your retirement plan. You may expect to be in a higher tax bracket in your senior years. Or maybe you want the peace of mind associated with having a tax-free income source in retirement. The Roth IRA works in either situation.

Once you confirm the Roth's place in your plan, automate your contributions and investments. That way, you only have to take action if you get a huge raise or bonus that pushes your income over the limit -- a great problem to have. Withdraw the excess contributions and earnings right away, and you'll be in the clear with the IRS.

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