With pension income rapidly becoming a thing of the past and the financial health of Social Security and Medicare threatened by a potential funding shortfall in the not-too-distant future, it's more important than ever to take responsibility for saving for your own retirement. One of the most flexible tools you have at your disposal to help you with your retirement saving is an IRA, and with a recent increase in IRA contribution limits, the IRS has given you a chance to put even more money aside for your golden years.
Getting a raise
Traditionally, the contribution limits for IRAs were set specifically in the tax law. For a 20-year span beginning in the early 1980s, the limit was $2,000 per year, but law changes in the early 2000s gradually raised the limit up to $5,000. Under laws that took effect back in 2008, the $5,000 amount was indexed for inflation. Low levels of price increases, however, kept the limit from rising until now, with the new limit of $5,500 taking effect for 2013.
If you're at least 50 years old, then you're entitled to take an additional "catch-up" contribution of $1,000. The contribution limits apply both to traditional and Roth IRAs, meaning that the total contribution you make to either or both types of accounts for any given year can't be more than the maximum limit.
Know all your limits
In addition to the contribution limits, though, there are other requirements that may keep you from contributing to an IRA. First and foremost, you have to have earned income from wages, salaries, or self-employment in order to put money in an IRA. If you earn less than $5,500 next year, then you'll be limited to whatever amount you earned.
On the other end of the spectrum, high-income taxpayers face certain limits as well. For Roth IRAs, there's a maximum income limitation that prevents higher-income taxpayers from making Roth contributions. Specifically, single taxpayers who make more than $127,000 or joint filers with more than $188,000 in adjusted gross income can't contribute to Roth IRAs.
Traditional IRA contributions are available to anyone who has earned income and is younger than age 70 1/2. But if you want to take advantage of the ability to deduct your contributions -- a benefit that can cut hundreds or even thousands of dollars off your tax bill -- then you have to earn less than certain income limits. The exact income amounts that trigger the limits depend on your marital status as well as whether you're covered by a 401(k) or other employer-sponsored plan at work; look to this page on the IRS website for more information.
How can you invest $5,500?
You may wonder how you can put together any sort of diversified portfolio with just a $5,500 limit to your IRA contribution. But the nice thing about IRAs is that you have almost the entire universe of available investments to choose from. Unlike a 401(k), where a specific menu of investment options is provided for you, you can go to nearly any financial institution and open an IRA.
All other things being equal, though, the best investments for an IRA take maximum advantage of its tax benefits. For instance, if you're optimistic about the ability of rural telecom providers to withstand competitive pressures and keep paying strong dividends, then Windstream (NASDAQ:WIN), Frontier Communications (NASDAQ:FTR), and CenturyLink (NYSE:CTL) would all help you defer tax on their lucrative dividend payouts. If you want to get even more diversification, then dividend ETFs iShares Dow Jones Select Dividend (NYSEMKT:DVY) or Vanguard Dividend Appreciation (NYSEMKT:VIG) are solid choices that emphasize dividend income.
Take it to the limit
With many people likely needing $1 million or more in savings for a secure retirement, a $500 rise in contribution limits may seem insignificant. But if you take your savings to the limit regularly, you'll put yourself in the best position to take advantage of tax-deferred or tax-free growth. That's a benefit you can't afford to give up right now.
Fool contributor Dan Caplinger owns shares of Vanguard Dividend Appreciation. You can follow him on Twitter @DanCaplinger. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.