Whether you don’t have access to a work-sponsored retirement plan, you’re unimpressed with your 401(k), or you simply want to save more each year, an IRA is a smart option to consider. With a traditional IRA or a Roth IRA, you can set aside even more money to fund your retirement goals — up to a certain point: Annual IRA contribution limits were set at $5,500 in 2016, or up to $6,500 if you’re age 50 or older. And, most of the time, they offer considerable tax advantages.
Before you dive in to either account, however, there are important differences to note between a traditional IRA and Roth IRA, along with some fine print about IRA contribution limits, deductions, and income guidelines that dictate who’s eligible to contribute to a Roth IRA. So let’s dig in.
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Which Type of IRA Should You Choose?
The term “IRA” is a simple acronym for the Individual Retirement Arrangement. By and large, these individual retirement accounts were created to allow people to save for retirement with unique tax advantages. The money you save in an IRA can be on top of funds you save in a work-sponsored retirement account, such as a 401(k) or 403(b). But since the two different types of IRAs are so diverse, it’s important to understand their differences.
A traditional IRA works similarly to a 401(k) in that the money you contribute this year is normally deductible on your taxes. That means if you contribute $5,500 in 2016, your taxable income for the year will drop by the same amount (in most cases – we’ll cover exceptions below). Over time, your money is able to compound and grow tax-free within the account. However, you’ll need to pay income taxes on your distributions once you reach retirement age and start withdrawing your money.
With a traditional IRA, you can only contribute until you reach age 70 ½. You’ll also need to take Required Minimum Distributions (RMDs) at that time.
A Roth IRA is almost the opposite of a traditional IRA. With a Roth IRA, the money you contribute is post-tax – as in, you’ve already paid income taxes on it and you won’t get any deductions in the current tax year. Your contributions are then able to grow tax-free in the account for the rest of your life. And once you begin taking distributions in retirement, you won’t have to pay taxes on the money at all.
With a Roth IRA, you can contribute for as long as you’re earning an income – even far past age 70 ½. (Some income caps apply, which we’ll cover below.) As an added bonus, you don’t have to take required minimum distributions at any time if you don’t want to. Even better, you can withdraw your contributions at any time without penalty. (Notice we said contributions, and not earnings.)
- Related: Roth vs. Traditional IRA: Retirement Showdown
How Much Can I Contribute to an IRA in 2016?
For both traditional and Roth IRAs, the contribution limit is the same in 2016.
- Ages 49 and younger: You can contribute up to $5,500 per year to a traditional IRA or Roth IRA.
- Ages 50 and over: You can contribute up to $6,500 per year in what is known as a “catch-up contribution.”
Also keep in mind that you can contribute to both types of IRAs, provided you qualify — but your contributions are still limited to the overall cap between both accounts. For example, if you’re under 50 and you contribute $3,000 to a Roth IRA, you can only contribute $2,500 more to a traditional IRA.
Who Can Contribute to a Traditional IRA?
The good news is that anyone who earns an income can contribute to a traditional IRA. And if you don’t have a 401(k) or other work-sponsored retirement plan, all of those contributions are tax deductible.
The bad news is, if you or your spouse already have an employer-sponsored retirement plan at work, such as a 401(k) or 403(b), you may not be able to deduct all (or even any) of your IRA contributions, depending on your income.
IRA Deduction Limits if You Have a Workplace Retirement Plan
Here’s how those deduction limits work for 2016 if you have access to a workplace retirement plan, per the IRS website:
If your filing status is single or head of household…
- You can take a full deduction up to the contribution limit if your modified adjusted gross income (MAGI) is $61,000 or less.
- You can take a partial deduction if your MAGI falls between $61,000 and $71,000.
- You lose your deduction for any MAGI $71,000 or higher.
If your filing status is married filing jointly or qualifying widower…
- You can take a full deduction up to the contribution limit if your MAGI is $98,000 or less.
- You can take a partial deduction if your MAGI is between $98,000 and $118,000.
- You lose your deduction for any MAGI over $118,000.
If you’re married filing separately…
- You get a partial deduction if your income is $10,000 or less.
- You lose your deduction when your income surpasses $10,000.
Who Can Contribute to a Roth IRA?
While anyone can contribute to a traditional IRA regardless of income, Roth IRA rules dictate certain income requirements must be met. In short, your income must fall under certain guidelines to contribute the full amount or a prorated amount to a Roth IRA.
The following table highlights who can contribute to a Roth IRA, and how much:
|Married Filing Jointly or Qualifying Widower||<$184,000||up to the limit|
|Married Filing Jointly or Qualifying Widower||between $184,000 and $194,000||a reduced amount|
|Married Filing Jointly or Qualifying Widower||>$194,000||zero|
|Married Filing Separately (and you lived with your spouse during the year)||<$10,000||a reduced amount|
|Married Filing Separately (and you lived with your spouse during the year)||>$10,000||zero|
|Single, Head of Household, or Married Filing Separately (and you did not live with your spouse at any time during the year)||<$117,000||up to the limit|
|Single, Head of Household, or Married Filing Separately (and you did not live with your spouse at any time during the year)||between $117,000 and $132,000||a reduced amount|
|Single, Head of Household, or Married Filing Separately (and you did not live with your spouse at any time during the year)||>$132,000||zero|
If you’re looking for another way to save for retirement, a traditional or Roth IRA might be exactly what you need. By arming yourself with information, you can find the best IRA account for your needs and investing style. And remember, the more you can save now, the better off you’ll be in retirement.
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- How and Where to Open a Roth IRA
- The $15 Retirement Plan
- Four Ways to Use a Roth IRA That Have Nothing to Do With Retirement
- Roth IRA vs. 401(k): You May Not Have to Choose