The IRS recently announced increases to the contribution limits for IRAs, which is especially interesting to those who have an IRA or are interested in setting one up to prepare for retirement. Whether you are coming closer to retirement age or you’re just beginning your career, you may want to consider taking advantage of the benefits that an IRA can offer. Take a look at the changes to the contribution limits as you determine how to apply this information in your investment strategy.
What is an IRA?
An individual retirement account, or IRA, is an account that is set up with a financial institution to save for your retirement on a tax-deferred or tax-free growth basis. The three main types of IRAs include traditional, Roth, and rollover. Each type has its unique benefits and drawbacks, so you should review the differences between all three types to determine which will offer the benefits that will best suit your needs.
In a traditional IRA, contributions are allowed to be deducted on the account holder’s annual tax return. The earnings can also grow on a tax-deferred basis until they are withdrawn during your retirement. Since a retiree is likely to be in a lower tax bracket than they were during their working years, the tax-deferred status can allow for taxation at a lower rate.
A Roth IRA is different from a traditional IRA in that all contributions are made with funds that have already been taxed. Therefore, any earnings from the funds in a Roth IRA are tax-free, and as long as you meet the requirements for this type of account, you can withdraw the money during your retirement without having to pay any additional taxes.
Rollover IRA contributions are rolled over from a different, qualified retirement plan. You can move eligible assets from an employer-sponsored retirement plan, such as a 403(b) or 401(k) into a rollover IRA. As long as the funds come from a qualified retirement plan, they can be moved into a rollover IRA without any penalties or risks.
For the first time in six years, the IRS recently increased the contribution limits for IRAs which allows individuals to invest more in planning for their retirement. Understanding the three main types of IRAs as well as the limits for each one can help you decide which account to choose and how much to set aside for your future.
What Are Contribution Limits?
The IRS imposes contribution limits on many different types of savings accounts, including IRAs, employer-sponsored retirement accounts, health savings accounts, and flexible spending accounts. Some contribution limits vary based on the age of the participant, while others are fixed for all account holders. The IRS can adjust these limits, often for inflation, but they exist to protect people from tying up too much of their income in accounts that can only be used for specific purposes as well as to prevent people from abusing the tax benefits associated with each type of account.
In 2019, the IRS increased contribution limits for traditional and Roth IRAs for the first time since 2013. The new limit is $6,000 per year if you are under the age of 50 and $7,000 per year if you are 50 years or older. For the 2019 tax year, you can contribute to your IRA between January 1, 2019, and April 15, 2020. Any contributions made after April 15, 2020, are applied to the 2020 tax year.
IRA contributions have several stipulations. Individuals are only allowed to contribute earned income to an IRA, which is income that is earned by working for someone else or from your own business and includes wages, tips, salaries, commissions, self-employment income, and bonuses. You can also contribute funds from disability retirement benefits, as long as you are under the age of eligibility to receive an annuity or pension if you weren’t disabled.
Income that does not count as earned income includes money from child support, alimony, rental properties, Social Security benefits, retirement income, unemployment benefits, payments received as an inmate in a penal institution, and dividends and interest from investments. If you do not earn income but your spouse does, you may qualify for a spousal IRA, which allows your spouse to contribute to an IRA on your behalf. To qualify for this type of account, you must be legally married and file your taxes jointly.
Why Invest in an IRA?
According to some financial experts, a retiree could need as much as 85% of their pre-retirement income to live comfortably during retirement. Simply contributing to an employer-sponsored savings plan, such as a 401(k), may not be enough to prepare for retirement, especially since these plans are also subject to contribution limits. When you have both an employer-sponsored retirement plan and an IRA, you can contribute to each account separately, allowing you to have more control over how much money to set aside for retirement.
Additional benefits of investing in an IRA include supplementing your current savings strategy, taking advantage of tax-free or tax-deferred financial growth, and gaining access to a larger range of investment options aside from a traditional employer-sponsored plan. By contributing the maximum amount to your IRA on an annual basis, you can make the most of this account and be better prepared for your future retirement.
SEP IRA Contribution Limits
A Simplified Employee Pension Individual Retirement Arrangement, or SEP IRA, is another type of IRA that is available to qualified participants. Business owners can use these accounts to provide retirement benefits to themselves and any employees who work for them. All employees must receive the same benefits under this type of plan, and the funds can be invested in the same way as other types of IRAs.
A SEP IRA is treated as a profit-sharing plan, which means that the employer must contribute funds on behalf of an employee. The total contribution limit cannot exceed the lesser of either $56,000 per year or 25% of the employee’s income. For self-employed individuals, the limit is 20% before self-employed tax deduction or 18.6% of net profits. SEP IRA earnings and contributions can be withdrawn at any time, although they are subject to the same limitations that are imposed on traditional IRAs.
SIMPLE IRA Contribution Limits
Small employers often use SIMPLE IRAs to provide employees with an opportunity to save for retirement. A SIMPLE IRA, or savings incentive match plan for employees IRA, is only available to small business owners with 100 or fewer employees. The contribution limits on this type of IRA also change annually, although often not as drastically as the limits imposed on other types of retirement and savings accounts. In 2019, the limit increased to $13,000 per year for participants under the age of 50. Those aged 50 and older can make a catch-up contribution of $3,000, bringing the limit to $16,000.
To qualify for a SIMPLE IRA plan, employers must also contribute to their employees’ retirement accounts. They can choose to match employee contributions dollar-for-dollar up to 3% of the employee’s salary or they can contribute up to 2% of an employee’s salary who elects not to contribute. When contributing 2% of the salary, the maximum contribution is $5,600.
When preparing for retirement, deciding how to invest can be overwhelming. Several different account options exist, making it tough to know which will offer the best returns and advantages when you reach retirement age. For help in planning your retirement, talk to an expert like the specialists at Raging Bull for help in making better sense of the different types of retirement accounts and plans. Professional, experienced, and knowledgeable financial trainers can answer your questions and provide you with information and insight to help you better prepare for a financially comfortable future.