An IRA contribution is money you contribute to a traditional, Roth, or other type of IRA in order to save for retirement. There are annual limits to how much individuals can contribute, and certain contributions may be tax-deductible, depending on the account owner's income and employment situation.
The short answer
An IRA contribution refers to money you deposit into an individual retirement arrangement, known as an IRA for short. IRAs are designed to help people build up a retirement nest egg by allowing them to save and invest money on a tax-advantaged basis.
The two main types of IRAs
For the majority of Americans, there are two choices when it comes to an IRA: traditional or Roth.
Traditional IRAs are designed for tax-deferred retirement savings. Contributions may be tax-deductible, and your investments are allowed to grow without capital gains or dividend taxes assessed on an annual basis, like they normally would be. Taxes are deferred until you withdraw your funds, at which point the withdrawn money is treated as ordinary taxable income.
Roth IRAs are designed for tax-free savings. The downside is that you don't get an immediate tax break for Roth contributions, but your qualifying withdrawals will be completely tax-free. Just like a traditional IRA, you won't have to worry about capital gains and dividend taxes in a Roth account.
To be able to withdraw from your account, you'll need to wait until you're at least 59-1/2 years old (or qualify for an exception), or face an early withdrawal penalty from the IRS.
There are more things to consider before choosing which type of IRA is best for you, so here's a thorough guide to the pros and cons of each.
How much can you contribute?
For the 2016 tax year, traditional and Roth IRA contributions are limited to $5,500, with an additional $1,000 "catch-up" contribution allowed for individuals age 50 or older. Keep in mind that this is a total contribution limit, meaning that if you have more than one IRA, your total contributions to all of the accounts must be equal to or less than these limits.
I say the "2016 tax year" because you can make contributions all the way up until the 2016 tax deadline of April 15, 2017 that will count for 2016. In other words, IRA contributions for a given tax year actually have a time window of about 15 and a half months in which they can be made.
The timing of contributions is significant because traditional IRA contributions may be tax-deductible, depending on your income and whether or not you have a retirement plan at work. And the ability to make Roth IRA contributions at all for a particular tax year depends on your income.
What can you do with your IRA contributions?
Invest! You can invest your IRA contributions in virtually any stocks, bonds, or mutual funds you'd like. Depending on your broker, there may be automatic investment plans available to you, or discounted (or waived) commissions for certain types of investments. Of course, you can always just leave your contributions in cash or in a money market account, but that's generally not the best idea.
Check out this and other great Foolish articles that can help you get started with IRA investing.
Additional options for self-employed people and small businesses
In addition to the traditional and Roth IRAs that I've discussed, individuals with self-employment income as well as small business owners have a couple more IRA options: SIMPLE IRA and SEP IRA. Click on each link for more information, but the general idea is that these options allow qualified individuals to set aside significantly more money than a traditional or Roth IRA allows, since for the most part, they aren't eligible for an employer-sponsored plan like a 401(k).
Stay tuned in 2017 and beyond
One important point to mention is that IRA contribution limits and some of the rules that go along with them, such as tax-deductible traditional IRA limits and Roth IRA income limits, are subject to change each year. The regular and catch-up IRA contribution limits have been $5,500 and $1,000, respectively, since 2013, however they have and likely will change in the future, so if you're reading this after 2016, be sure to check the most current information from the IRS.
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