This article was originally published on Jan. 11, 2015, and updated on Dec. 18, 2015.
If you're tapping the power of an IRA to build wealth for your retirement, good for you! Be sure you know what the IRA contribution limits are from year to year, though, so that you can maximize your results. With a little cleverness, you may even be able to exceed the limits in some years.
Traditional vs. Roth
First off, understand that there are two main kinds of IRAs -- traditional and Roth. 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 $60,000 and a $5,000 contribution? Presto -- $55,000 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 $60,000 and a $5,000 contribution? You've still got taxable income of $60,000 for the year.) But here's why so many like the Roth IRA: Your money grows in the account until you withdraw it in retirement -- tax free.
IRA contribution limits
The IRA contribution limits are the same for both the 2014 and 2015 tax years: $5,500 -- plus an extra $1,000 "catch-up" contribution for those age 50 or older. (Note that while limits are increased now and then, to keep up with the cost of living, they will remain the same for 2016, as well.)
Roth IRA contributions must be made with earned money. There's no minimum age for opening a Roth, but whoever funds one, 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, pension or disability income, or Social Security benefits.
Roth IRA limits for 2014 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 $114,000, and married couples who file jointly and have AGIs of less than $181,000, are safe. For 2015, those numbers are $116,000 and $183,000, respectively.
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.
How to sock away more than the IRA contribution limits allow
If you're thinking that it's December 2015 now, so you'd better hurry and make a contribution to your IRA for 2015, you're in luck: 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 make it by April 15.
There are other ways to tweak how much you sock away, or where it sits and grows. For one thing, 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. There's a catch, of course: Whatever you convert was never taxed, so you 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. 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 IRAs, too, though again, taxes are sometimes involved.
Think a little outside the box, as well. If you max out your IRA contributions, give some thought to any retirement accounts 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 the employers (matching = free money). The 401(k) and 403(b) limits for 2014 are $17,500, plus an additional $5,500 for those 50 and older (for a total of $23,000). They rise to $18,000 (plus $6,000 for older contributors, for a total of $24,000) in 2015 -- and stay at those levels for 2016, as well.
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, which take post-tax dollars in exchange for tax-free withdrawals. Both kinds of plans typically feature a bunch of mutual funds from which you can choose. 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 usually among the options, and those can be 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. With a SIMPLE IRA, there's a higher contribution limit of $12,000 in 2014, and $12,500 in 2015 and 2016. Notice that by maxing that out along with a regular traditional or Roth IRA, you'll reach the 401(k) limit of $17,500 in 2014, and $18,000 in 2015 and 2016. With a SEP IRA, which gets its name from Simplified Employee Pension, you can contribute the lesser of 25% of your compensation, or $52,000 for 2014. For 2015 and 2016, it's $53,000.
If you're gazing at the 2015 IRA contribution limits and thinking that you can only sock away $5,500 this year in a tax-advantaged account, think again. With a little strategizing, you can make your retirement even sweeter.