If you have an IRA, or are considering opening one, you might be wondering how much you can contribute every year. And it’s a good question! Both traditional and Roth IRAs have set contribution limits, as well as other guidelines, and these differ from the rules for 401(k)s and other retirement accounts.
There’s a lot of confusion around IRAs and 401(k)s. Additionally, many borrowers have not begun saving for retirement. According to Northwestern Mutual’s Planning & Progress 2019, 22% of Americans have under $5,000 in retirement savings, and 15% have nothing saved at all. These figures include 401(k)s and IRAs. Many folks working in the United States are offered a 401(k) at work, and the process may be automatic.
With an IRA, a retirement investor typically has to go out on their own and find one that fits their needs, which may lead to even more confusion about how much they can, and should, be contributing. The statistics show that less than half of American households have contributed to an IRA.
Just “35% of households contributed to traditional IRAs, while 36% contributed to Roth IRAs. 20% contributed to more than one type of IRA, while 9% contributed to a SEP or SIMPLE IRA.”
It might be that some retirement investors don’t even know that this retirement investing vehicle exists, or how they can take advantage of it.
What Is an IRA?
An IRA stands for individual retirement account. Like a 401(k), it has special tax advantages because it is meant for retirement savings. The main difference between a 401(k) and a traditional IRA is that the 401(k) is a plan offered by an employer and may come with a matching contribution.
There are a few different kinds of IRAs available.
A retirement investor’s contributions to a traditional IRA are typically tax deductible. Investors won’t pay taxes on earnings with a traditional IRA. When an investor reaches retirement age, they’ll pay taxes on withdrawals because they’re taxed like income. It’s almost like paying yourself a salary in retirement and paying income taxes on those payments.
Contributions to a Roth IRA are made after taxes and aren’t tax deductible. With a Roth IRA, earnings aren’t typically taxed, but investors won’t have to pay taxes on withdrawals from a Roth IRA when they reach retirement age and start using the funds in one of these accounts.
A Sep IRA is a simplified employee pension IRA. These IRA accounts help small businesses or self-employed retirement investors make contributions to an IRA in the employee’s name.
A Simple IRA is the closest IRA to a 401(k). This account, which is a savings incentive match plan for employees, can be set up by small businesses that don’t have any other retirement plans for employees. Like a 401(k), this IRA lets employees and employers make contributions, but with lower costs and fewer administration fees than a typical 401(k).
How Can an Investor Open an IRA?
Investors thinking about opening a new IRA may have to take a few simple steps to get ready for the process. Investors may want to think early about whether a Roth or a traditional IRA makes sense.
Roth IRAs have some limitations that might preclude investors from getting one.
Investors who make $203,000 a year filing taxes jointly or $137,000 a year filing single may not be eligible to open a Roth IRA. If an investor doesn’t meet these income thresholds, they’re probably ready to get started with a Roth IRA.
The steps are fairly straightforward. An investor will probably need the following information to start the process, most of which can be completed online. Vital information needed to open a Roth IRA includes: a driver’s license or ID, social security number, banking info like routing numbers to fund the account, name and address of employer, and beneficiary information. After that, investors choose an asset mix and investment type that makes sense for their goals.
Opening a traditional IRA can also be completed online and will probably require most of the same information that’s needed to open a Roth IRA.
What if Investors Need to Rollover Funds?
Some investors might be thinking about a Roth IRA or a traditional IRA because they have left a job where they had a retirement account and need to move those funds to a new account. Most of the funds from this type of account can be rolled over into a new account within 60 days.
The advantage of rolling over a retirement to another account is that investors don’t lose the tax-deferred status of those funds. If investors don’t roll over the funds, they do become taxable.
There are three ways investors can rollover retirement funds into an IRA.
The administrator of an investor’s old retirement funds, perhaps at a previous job, can rollover funds into a new account directly. They may cut a check to the investor that is made out to the new account.
If an investor is getting funds from an IRA, they can ask the financial institution that administers the old IRA to make the payment to the new IRA. The investor won’t pay taxes on this transfer.
If an investor is paid a distribution directly from an IRA or retirement plan, they can deposit all or a portion of it into an IRA or retirement plan. However, the distribution will be taxed.
How Much Can You Contribute to an IRA Each Year?
If you’re younger than 50, you can contribute a maximum of $6,000 annually to either a traditional IRA or a Roth IRA.
After 50, you’re allowed to make “catch-up” contributions, so the cap goes up to $7,000 a year. Once you reach the age of 70.5, you can no longer make regular contributions to a traditional IRA; there’s no age limit for a Roth IRA.
Limits for Roth IRA and traditional IRA contributions 2020:
• Under age 50: $6,000
• Age 50 to 70.5: $7,000
• Age 70.5 and up: $7,000 for a Roth IRA
• Age 70.5 and up: Nothing for a Traditional IRA
Of course, nothing about retirement planning is simple. There are a few exceptions to the retirement contribution limits. If you make less than the limit in taxable income, you can only contribute up to that amount. On the other end of the spectrum, if you make too much, you won’t be able to contribute to a Roth IRA, or may only be able to contribute a reduced amount.
For 2020, if you’re single, you can put in a reduced amount if you make between $122,000 and $137,000; above that, you can’t contribute anything.
For a married person filing jointly, you can contribute a reduced amount if you make between $193,000 and $203,000. (The limits are based on modified adjusted gross income .)
Still unsure which IRA account you can contribute to? Use SoFi’s IRA Calculator to help you make an informed decision.
Can You Withdraw From an IRA Before Retirement?
Not necessarily. With a Roth IRA, there are situations where you can withdraw your contributions with no penalties or taxes. You can take out up to $10,000 from a traditional IRA—or in earnings from a Roth IRA—without penalties for expenses associated with buying your first home.
You can also withdraw funds penalty-free for qualifying medical or educational expenses. And once you hit the age of 59.5, distributions will always be penalty-free.
Are There Ways to Get Around IRA Contribution Limits?
Sometimes. There’s no limit to how much you can put into an IRA when you’re rolling over funds from a 401(k) or 403(b) account.
Some people also use what’s called a “backdoor Roth IRA” to get around the income limits to contribute to a Roth IRA. This involves contributing the maximum to a Traditional IRA, then converting it into a Roth. (There’s no income limit for conversions.) This can be tricky, though, so consult a tax professional so you understand all the tax implications.
Is an IRA a Replacement for a 401(k)?
Investors who are one of the roughly half of American households who are offered a 401(k) at work might be able to take advantage of both retirement savings vehicles. Many experts agree that those with access to a 401(k) will likely end up saving more because the savings are automatically deducted.
And, some investors might even be able to get additional 401(k) savings in the form of an employer match. These matches reached a record high of record high of 4.7% in 2019 . Investors who have access to a 401(k) and an IRA might be able to accelerate their retirement savings and put themselves in a better financial situation when they reach retirement age.
Yes, all the rules of IRAs can be complicated, but investing in one doesn’t need to be. SoFi Invest® is all about empowering you and your financial future. Need tips on IRAs, or saving for retirement in general? Schedule a complimentary personal consultation with one of our licensed financial advisors who can answer your questions.
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