If you're familiar with IRA contribution limits, you might think they're on the small side. It's true that you can't sock away tens of thousands of dollars in IRAs each year, but that doesn't mean they can't be powerful components of a comfortable retirement. Let's delve into what the limits are for this year and next -- as well as how you might make the most of them.
Kinds of IRAs
First off, understand that there are two main kinds of IRAs -- the traditional IRA and the Roth IRA. With a traditional IRA, you contribute pre-tax money, reducing your taxable income for the year, and thereby reducing your taxes, too. (Taxable income of $75,000 and a $5,000 contribution? Presto -- $70,000 in taxable income for the year.) The money grows in your account, and is taxed at your ordinary income-tax rate when you withdraw it in retirement.
With a Roth IRA, you contribute post-tax money that doesn't reduce your taxable income at all in the contribution year. (Taxable income of $75,000 and a $5,000 contribution? Your taxable income remains $75,000 for the year.) Here's the selling point of the Roth, though: Your money grows in the account until you withdraw it in retirement -- tax free.
IRA contribution limits
IRA contribution limits are adjusted every year or every few years, to keep up with the cost of living. Inflation has been low lately, so the limits for both 2015 and 2016 are the same (and are the same as they were in 2014, too): $5,500. There's also an extra $1,000 "catch-up" contribution permitted for those age 50 or older, letting those folks sock away as much as $6,500 for the year.
The $5,500 or $6,500 limit applies to all your IRAs. If you have a Roth IRA and a traditional IRA, or even more IRAs, your total contributions to them all are capped at $5,500 or $6,500, distributed any way that you want. The limit is not per IRA account.
Roth IRA contributions must be made with earned money. There's no minimum age for opening a Roth, but anyone funding a Roth IRA, whether child or adult, must do so with earned income. For kids, allowance or birthday money doesn't qualify, but cash earned through babysitting or odd jobs can. For adults, qualified earnings include wages, commissions, and even alimony payments, but not inheritances, Social Security benefits, or pension or disability income.
Roth IRA limits for 2015 and beyond include income limits, too, as the ability to contribute to a Roth IRA is reduced or eliminated for high earners. Single filers with modified adjusted gross income (AGI) of less than $116,000, and married couples who file jointly and have AGIs of less than $183,000, are safe. For 2016, those figures rise to $117,000 and $184,000 respectively. If your AGI is above the limit, your limit will be reduced, or you may not qualify to contribute to a Roth at all.
With traditional IRAs, people earning any level of income can contribute to them, but there are income-based limits on how much one can deduct for contributions to a traditional IRA. Thus, the overall effect is similar to Roth IRA income limits, reducing the usefulness of these tax-advantaged retirement accounts for wealthier folks.
Exceeding the limits
Despite the IRA contribution limits, you may still be able to sock away more than the limits allow -- legally.
For one thing, the deadline for IRA contributions is actually the same as your tax-filing deadline, April 15. Thus, if you don't make a contribution by the end of 2015, you can make two in 2016, as long as you specify that one is for 2015 and you send that one in by April 15.
There are other ways to tweak how much you sock away, or where it sits and grows. For example, you can convert a traditional IRA to a Roth one, even if the traditional IRA has way more than $5,500 or $6,500 in assets. That may sound terrific, but there's a catch: Since whatever you convert from a traditional IRA was never taxed, you'll have to pay income tax on it for the year of conversion.
That can be a deal breaker sometimes, so run the numbers first to see if it makes sense for you. (Converting a $40,000 account and in the 25% tax bracket? Can you handle an extra $10,000 in taxes?) You might even be able to convert your 401(k) to a Roth IRA. And a 401(k) account from a job you've left or are leaving can be rolled over into an IRA, too, though again, taxes are sometimes -- but not always -- involved. (Rolling over 401(k) assets into an IRA when you change jobs is often a far smarter thing to do than just cashing it out.)
If you max out your IRA contributions and can still sock away more money toward your retirement, remember the retirement accounts that may be available at your workplace, such as a 401(k) or 403(b) account. Those have far bigger contribution limits, and often feature matching funds from employers, too. (Matching dollars are free money, so it's smart to contribute at least enough into such accounts as needed to grab all the available matching funds.)
The contribution limits for 401(k) and 403(b) accounts for 2015 and 2016 are the same: $18,000. Those 50 or older can make an additional catch-up contribution of up to $6,000, for a total contribution for the year of $24,000. Compared to IRA contribution limits, these are clearly more generous. Using both of these kinds of accounts, you can sock away a lot of money for your future.
Regular 401(k) accounts work much like traditional IRAs, accepting pre-tax dollars and taxing withdrawals. Increasingly, though, many employers are offering Roth 401(k)s as another option. These accounts accept post-tax dollars and offer tax-free withdrawals, if you follow the rules.
Both kinds of plans typically feature a menu of investment options for your money, such as a range of mutual funds. That's more restrictive than IRAs, which can be set up at your friendly local brokerage, permitting you to fill them with just about any stock, and any of possibly hundreds of mutual funds. Still, index funds are very often among the options with a 401(k) account, and those can be good enough for most of us.
Self-employed people have a few more options, such as SEP IRAs or SIMPLE IRAs, which are also good options for small businesses. The SIMPLE IRA has a contribution limit of $12,500 in 2015 and 2016. The SEP IRA, which gets its name from Simplified Employee Pension, lets you contribute the lesser of 25% of your compensation or $53,000, for 2015 and 2016.
The bottom line is that for 2015 and 2016, the IRA contribution limits are $5,500 -- or $6,500 for those 50 or older. But there's more to it than that, and by applying a little strategy and looking beyond IRAs to other retirement accounts, you may be able to sock away much more than the IRA limit, and build a more comfortable future.
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