When it comes to saving for retirement, finding the cash to put away each month is only half the battle. The other half? Navigating the rules for the different types of accounts.
But before you give up in frustration and stash your cash in a simple savings account, which won’t help you make much money on your money (see compound interest), read this primer on contributing to IRAs. These types of accounts can help you grow your nest egg for the retirement you want — and the rules aren’t so hard to follow.
WHAT ARE IRAs?
IRA stands for individual retirement account. It’s basically an account that lets you save for retirement with some tax advantages. There are two main types of IRAs: a traditional IRA and a Roth IRA.
A traditional IRA is similar to a 401(k) (which is only offered through your employer), in that you can deduct your contributions on your tax return. This helps lower the amount of income you’re ultimately taxed on. But when you're older and grayer and spending your days on the golf course, you’ll be taxed on the cash you withdraw.
A Roth IRA is the opposite from a tax perspective. You don't get to deduct the contributions you make now, but when you're older, you can take money out of your Roth IRA to travel the world or spoil your grandkids, and you won’t have to pay taxes on what you withdraw. (Side note: There are also now Roth 401(k)s. These follow the same rules as traditional 401(k)s, except they are taxed the same way as the Roth IRA — now, not later.)
CONTRIBUTION AND INCOME CAPS
Ready to start contributing to an IRA? Not so fast. There are traditional IRA and Roth IRA caps you should know about. For starters, there’s a limit to how much you can contribute each year: You can put up to $5,500 into a traditional IRA in 2017. (It will be the same in 2018.) If you are 50 or older, you can add an extra $1,000.
If you or your spouse is covered by a retirement plan at work, you can still contribute to an IRA, but depending on how much you make, you may not be able to deduct those contributions on your taxes. If you’re single, deductions start to phase out when you make $62,000. If you make more than $72,000, you can no longer deduct traditional IRA contributions. If you’re married (and filing jointly) your phaseout for a deduction starts at $99,000 and ends at $119,000. However, if only one of you is covered by a retirement plan at work, the one who isn’t covered can deduct IRA contributions with a phaseout that starts at $186,000 and goes up to $196,000.
Roth IRA caps are also complicated. While the maximum you can contribute is the same as a traditional IRA, if you make too much, you can’t contribute to a Roth IRA.
If you file taxes on your own and your income after deductions is $118,000 or less, you can contribute the full $5,500. But if your income after deductions is between $118,000 and $133,000, then you can only make a partial contribution. Anything over that, and you're out of luck!
If you file taxes as a couple, you have to make under $186,000 in order to make a full contribution, and between $186,000 and $196,000 to make a partial contribution. (These amounts will go up in 2018.)
Pro tip: If you make too much to contribute to a Roth IRA, you could always contribute to a traditional IRA and then convert it to a Roth later. You may have to pay taxes at the time you make the conversion, but you won’t have to pay tax later on in retirement.
With your 401(k), New Year's Eve is your last hurrah for putting money into your account for the tax year. But if you have an IRA and get too busy watching the ball drop, fear not: You can contribute to an IRA until Tax Day (April 17, in 2018), to put money away for the previous year’s tax return.
BUT WHAT IF I HAVE A 401(k)?
IRAs are just one part of the retirement savings pie. You might be wondering whether you should prioritize contributing to an IRA over your 401(k). It always makes sense to put money in your 401(k) if your employer is matching your contributions. (Why turn down free money for retirement?)
After you contribute enough to get the full match from your employer, though, you might choose to put any extra retirement savings into an IRA or Roth IRA rather than max out your 401(k), depending on your goals and what type of tax treatment you’re looking for — talk with your financial professional and compare your options to see which will work best with your financial plan.
All investments carry some level of risk including the potential loss of principal invested.
No investment strategy can guarantee a profit or protect against loss.
Distributions may be subject to ordinary income tax and may be subject to a 10 percent IRS early withdrawal penalty if taken before age 59 ½.