Saving for retirement can be challenging for many Americans, with many people finding it difficult to find cash to spare. But putting aside this money is vitally important for a secure financial future, and saving through an individual retirement account — also known as an IRA — is one way to do so.
There are two types of IRAs, a traditional IRA and a Roth IRA. Both types allow your contributions to grow tax-free, which means that all of the money in your account can grow without you paying taxes on that growth. The primary difference between the two types is how you are taxed: before you put the money into the account or when you take it out. For Roth IRAs, the money you contribute has already been taxed (in other words, it is treated as taxable income). For traditional IRAs, the contributions are not taxed, but the withdrawals from the account are taxed as income. The decision between choosing a traditional or a Roth IRA depends on a number of factors, including what your predicted income at retirement will be compared to your income during your working years.
Roth IRAs have certain income limits. For single filers, only those with an adjusted gross income below $118,000 can contribute to an account. For incomes between $118,000 and $133,000, the contribution amount begins to taper off. For married (filing jointly) filers, only those couples with an adjusted gross income below $186,000 can contribute. Contributions begin to taper off between $186,000 and $196,000. Traditional IRAs have certain income limits only if you are already contributing to a retirement plan through your employer. In that case, you can still contribute to an IRA, but you might not be able to deduct your contribution on your tax return.
So how much can you contribute to an IRA? For 2017, the answer is $5,500 if you are under the age of 50 and $6,500 if you are age 50 or older. That is for both types of IRAs, and if you have one of each type of IRA, your total contributions cannot exceed that amount (either $5,500 or $6,500). The higher limits for age 50 and older are known as catch-up provisions; they are designed to allow older Americans to “catch up” on their retirement savings by putting more into their IRA accounts as they get closer to retirement age. However, there is an exception: rollovers from an employer sponsored account, such as a 401(k), do not count as contributions for the purposes of this rule.
Importantly, if you have put too much into your traditional or Roth IRA, you may face a fine from the IRS. This 6% fine can be costly, so be sure to carefully track how much you are putting into your account. If you have put in above the permitted amount, you can withdraw them before you file your taxes, or withdraw them and amend your taxes. You should talk to a tax advisor if you believe that you have put too much into your IRA and are worried about being hit with a fine or penalty from the IRS.
An IRA is just one part of a well-rounded retirement savings plan. While the contribution limit is relatively low, in combination with other types of savings — such as 401(k) plans — an IRA can form the basis for a properly funded retirement.