Patrick Horning is an advanced planning attorney at Northwestern Mutual.
Higher-than-normal inflation has impacted the pocketbooks of consumers across the U.S. over the last year. No matter your income level or net worth, the effects of high inflation can be felt almost daily at the gas pump and grocery store. While it’s hard to find something positive to say about the current inflationary environment, there might just be a silver lining, particularly for those with higher incomes.
Earlier this month the IRS announced new limits for a variety of tax exemptions and other rules. Certain limits, such as how much you can contribute to your IRA and the annual gift tax exclusion, are pegged to inflation. With low inflation during the past decade, we’ve grown accustomed to seeing these figures increase slowly. But with current inflationary levels, taxpayers will see a larger-than-normal increase in select figures for 2023.
6 IRS Limit Increases That May Benefit You
The following are six recently announced IRS limit increases that may provide you with a financial planning opportunity in 2023:
1. Standard deduction
The standard deduction is set to increase from $12,950 to $13,850 for single taxpayers in 2023, and from $25,900 to $27,700 for those married, filing jointly. For taxpayers age 65 and older or blind, these figures increase to $15,700 and $29,200, respectively.
For taxpayers who do not itemize, which since the passage of the Tax Cuts and Jobs Act in 2018 now includes more high-income earners than before, the higher standard deduction potentially means less income subject to taxation.
2. Qualified plan contributions
The maximum deferral for qualified plans, including 401(k) and 403(b) accounts, is set to increase from $20,500 to $22,500 in 2023. The catch-up contribution for those age 50 and older will also increase, from $6,500 to $7,500. As a result, high-income taxpayers who are already maxing out their contributions to qualified plans will be able to defer an even larger amount in 2023.
3. IRA contributions
The maximum IRA contribution amount will increase from $6,000 to $6,500 in 2023 for both traditional and Roth accounts. The IRA catch-up contribution for taxpayers age 50 and above will not increase because that $1,000 limit is not indexed to inflation. While several bills in Congress propose changing this, none have been signed into law as of this writing.
4. IRA phaseouts
Depending on your income level, you may not have had the ability to contribute the maximum IRA contribution amount in prior years. This is due to IRA phaseouts, which limit the ability of high-income earners to take advantage of these accounts. However, in 2023 IRA phaseouts will also increase, benefiting those with incomes that may now fall within or even below the new ranges.
In 2023, the IRA phaseout thresholds increase as follows:
5. The lifetime gift and estate tax exemption
Thanks to the lifetime gift and estate tax exemption, every taxpayer can pass a certain amount of money to their heirs during life and/or at death without paying gift or estate tax. In 2022, the unified lifetime exemption is capped $12.06 million per taxpayer, but in 2023 it rises to $12.92 million.
For high-net-worth Americans, this means you can pass an extra $860,000 to your heirs over the course of your lifetime as a gift and/or via your estate without paying tax. If you are planning as a married couple, you qualify for two lifetime exemptions. For couples, the new IRS limit increases your exemption by $1.72 million, bringing your combined unified lifetime estate and gift tax exemption cap to $25.84 million.
6. The annual gift tax exclusion
Taxpayers can also give smaller amounts away each year without touching their lifetime gift tax exemption. This is called the annual gift tax exclusion. In 2022, the annual gift tax exclusion is set to $16,000 per donor, per donee. In 2023, this number increases to $17,000.
While an extra $1,000 may not seem like a significant increase, consider the following hypothetical scenario. You and your spouse have four children and you’re lucky enough to have a total of 10 grandchildren. Together, you’ve built significant wealth, and your combined estate easily exceeds your collective gift and estate tax lifetime exemption of $25.84 million in 2023. To help reduce your taxable estate at death, you and your spouse have each been gifting the annual exclusion amount to every child and grandchild each year. In 2023, instead of being able to remove $448,000 ($32,000 for every child and grandchild because you are giving as a couple) from your taxable estate via gifts as you did in 2022, you’ll be able gift an extra $28,000 (for a total of $476,000) in 2023 thanks to the increase.
It’s Not All Good News: The Social Security Wage Base Increase
While it’s clear to see how these 2023 IRS limit increases can create a powerful financial and tax planning opportunity for Americans with significant wealth, it’s not all good news. It’s worth noting that the Social Security Wage Base (the maximum wage subject to Social Security tax each year) will also increase. In 2022, that figure is $147,000. It rises to $160,200 in 2023, meaning Social Security taxes will be owed on an additional $13,200 of income for some high-income earners in 2023.
Meet With Your Financial Advisor Today
As the end of 2022 nears, it’s a great time to plan for the impact 2023 IRS limit increases can have on your financial plan. Likewise, it’s also a great time to act on 2022 year-end tax planning opportunities, which may include tax-loss harvesting and charitable gifting strategies, as many will pass when the clock strikes midnight on Dec. 31, 2022. Meet with your financial advisor well before year-end to discuss which planning opportunities might be right for you this year and next.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.
This article is not intended as legal or tax advice. Northwestern Mutual and its financial representatives do not give legal or tax advice. Taxpayers should seek advice regarding their particular circumstances from an independent legal, accounting or tax adviser.
As a senior director in the Advanced Planning department at Northwestern Mutual, I work with Northwestern Mutual financial advisors as they help clients achieve financial security.