The maximum amount retirement savers can contribute to a traditional IRA for 2018 is unchanged from 2017. However, the income limits to qualify for a tax deduction of your IRA contributions are slightly higher for 2018 than they were for 2017. And even though it's already 2019, there's still time to make a prior-year contribution to your IRA for 2018.
IRA Contribution Limits for 2018
The maximum amount you can contribute to a traditional IRA for 2018 is $5,500 if you're younger than age 50. Workers age 50 and older can add an extra $1,000 per year in "catch-up" contributions. You must have earnings from work to contribute to an IRA, and you can't put more into the account than you earned. In 2019, the IRA contribution limit increases to $6,000; the catch-up contribution limit is staying the same.
Your 2018 IRA contributions may also be tax-deductible. If you--and your spouse, if married--don't have a retirement plan at work, such as a 401(k), you can deduct the full contribution to your traditional IRA on your tax return no matter how much you earn. You have until the federal tax filing deadline to make your IRA contribution for the previous year. For most taxpayers, the deadline for filing 2018 tax returns is April 15, 2019.
Even if you have a retirement plan on the job, you may still be able to deduct some or all of your contribution depending on your income. For 2018 IRA contributions, the amount of income you can have and still get a full or partial deduction rises slightly from 2017. Singles with modified adjusted gross income of $63,000 or less and joint filers with income of up to $101,000 can deduct their full contribution for the 2018 tax year. Deductions thereafter decrease and phase out completely once income reaches $73,000 for singles and $121,000 for joint filers.
For 2017, singles with modified adjusted gross income of up to $62,000 and married joint filers with income of $99,000 or less were able to deduct their full contributions. The 2017 deduction phased out as income rose above those levels, and it disappeared entirely once income reached $72,000 for singles and $119,000 for joint filers.
Be aware that you generally must have earned income to contribute to an IRA. But if you're married and one of you doesn't work, the employed spouse can make a contribution into a so-called spousal IRA for the other.
You can open a traditional IRA through a bank, brokerage, mutual fund or insurance company and invest your IRA money in stocks, bonds, mutual funds, exchange-traded funds and other approved investments.
Why Save for Retirement in an IRA?
Traditional IRAs are best for people "who need an immediate tax deduction or want to defer income in the hopes that their bracket will be lower in the future," according to Mari Adam, a certified financial planner in Boca Raton, Fla. The latter category includes people expecting to retire shortly and those who believe their income will go down in future years, she says.
The tax deduction plus the tax-deferred growth that a traditional IRA provides can help build a sizable retirement nest egg. For example, a 25-year-old who contributes $5,500 a year to a deductible IRA and has an annual return of 6% will accrue a nest egg of $902,262 at age 65. If instead he or she is in the 22% tax bracket and invests the funds in a taxable account earning a 6% annual return, the account would grow to about $643,500 by age 65. The difference is the brake that paying the IRS on each year's earnings puts on compounded growth.
Eventually, you will have to pay taxes on your traditional IRA. Your withdrawals will be subject to ordinary income tax. On top of that, if you take the money out before turning age 59½, you can be hit with a 10% penalty. You will also be obligated to take required minimum distributions (RMDs) after you turn age 70½, so you won't be able to avoid the IRS forever.
Roth IRAs vs. Traditional IRAs
The tax rules differ for contributions to a Roth IRA, which aren't tax-deductible. Money instead goes into a Roth IRA after taxes have been paid on it, and you can withdraw contributions at any time free of taxes or penalties. The earnings can also be withdrawn tax- and penalty-free once you have owned the Roth for five years and you're at least age 59½. Also, Roth IRAs don't have required minimum distributions. The amount that can be contributed to a Roth IRA is subject to income limits.
Also, you can add funds to a Roth IRA at any age, provided you have earned income from, say, a job or self-employment. Traditional IRAs close the door to new contributions once you turn 70½, even if you're still working.
If you can afford to contribute the full $5,500 without the help of the tax deduction (which reduces the out-of-pocket cost of a $5,500 contribution to just $4,290 for someone in the 22% bracket) you may be better off saving for retirement in a Roth IRA.
One final note: If you invest in both a traditional IRA and a Roth IRA, the total amount of money you can contribute to both accounts can't exceed the annual limit. If you do exceed it, the IRS might hit you with a 6% excessive-contribution penalty.
Copyright 2018-2019 The Kiplinger Washington Editors