Many Americans are falling short of saving for retirement, and as a result, too many are worrying about their financial security later in life. Since preparing for your golden years can reduce the chance you'll come up short when you retire, you may be planning to contribute money to a traditional or Roth IRA this year. If so, then you should know that the Internal Revenue Service allows most Americans to contribute up to $5,500 to an IRA in 2016 or up to $6,500 if you're over age 50.
While contributing to an IRA is a great way to set aside money for retirement, there are different rules that may limit your ability to make a traditional or Roth IRA contribution this year. If your income is above specific limits and you participate in a retirement plan at work, for example, you may not be able to deduct your contribution to a traditional IRA in 2016. As a refresher, traditional IRAs are funded with pre-tax dollars that can lower your tax bill now. However, money that's eventually withdrawn from a traditional IRA in retirement is taxed at your then-current tax rate.
Most people invest in a traditional IRA because of that tax-deferral benefit. However, if you're single and covered at work by a retirement plan, such as a 401(k), your ability to deduct a traditional IRA contribution begins phasing out once your income eclipses $61,000 in 2016. If you're married and covered by a workplace plan, your tax deduction begins phasing out once your combined income exceeds $98,000 in 2016. If you're married and you aren't covered by a plan at work but your spouse is covered by a workplace plan, the deductibility of contributions begins to phase out when your income exceeds $184,000 in 2016.
The rules that apply to Roth IRA contributions aren't the same as those for traditional IRAs. Contributions to a Roth IRA are made with after-tax dollars. However, withdrawals, including earnings, are tax-free once you're 59 1/2 years old, as long as the Roth IRA has been in existence for at least five years.
To contribute the full amount to a Roth IRA in 2016, however, you'll need to earn less than $117,000 if you're single or less than $184,000 if you're married. If you earn more than that, you can't contribute to a Roth IRA. However, you may be able to make a non-tax deductible contribution to a traditional IRA that can be converted later to a Roth IRA. This strategy is a bit complicated, so consult with your accountant to see if this option is right for you.
Making a difference
IRAs are a fantastic way to supercharge your retirement savings, especially if you can also max out a workplace plan. If you participate in a 401(k) or 403(b) plan at work and you qualify to contribute to an IRA, you can set aside up to $18,000 in your workplace plan ($24,000 if over age 50), plus up to $5,500 ($6,500 if over age 50) in an IRA. Conceivably, that means that a person who is under age 50 could save a combined $23,500 in 2016.
That's a lot of money and contributing that amount every year can result in a millionaire-making portfolio. For example, if you invest $23,500 per year in an investment returning a hypothetical average 6% annually, you'd end up with a nest egg worth nearly $1.3 million in 25 years.
You can contribute to a traditional IRA up until age 70 1/2. At that point, the IRS makes you start taking withdrawals from a traditional IRA. You may contribute to a Roth IRA at any age, but you can contribute only up to the amount you earn from working to both a traditional or Roth IRA. So, if you work part-time and you only earn $3,500 from that work, then $3,500 is the maximum you can contribute to either a traditional or Roth IRA in 2016.