For the first time since 2008, contribution limits have risen for one of the most popular retirement savings vehicles available: the IRA. This means you’ve got a greater opportunity to put more money away for your “golden years.”
Effective earlier this year, you can now put in up to $5,500 (up from $5,000 in 2012) to a traditional or Roth IRA when you make your 2013 contribution. And if you’re 50 or older, you can put in an additional $1,000 above the new contribution limit.
Over time, the extra sums from the higher contribution limits can add up. Consider this example: If you put in $5,000 per year to an IRA for 30 years, and you earned a hypothetical 7% per year, you’d wind up with slightly over $505,000. But if you contributed $5,500 per year for those same 30 years, and earned that same 7% per year, you’d accumulate almost $556,000 - about $51,000 more than with the lower contribution limit.
Keep in mind that if you have invested the above amounts in a traditional, tax-deferred IRA, you’ll be taxed on your withdrawals at your ordinary income tax rate. With a Roth IRA, your contributions are made with after-tax funds, but your withdrawals have the potential to be tax-free - provided you’ve had your account at least five years and don’t start taking withdrawals until you’re 59 percent. (Not everyone is eligible to contribute to a Roth IRA, as income limits apply.)
If you have an IRA, you already know its advantages. If you aren’t investing in an IRA, you should be aware of these key benefits:
Tax-deferred growth - A traditional IRA can provide tax-deferred growth while a Roth IRA can potentially grow tax-free, provided you meet the conditions described above. To get a sense of just how valuable these tax advantages are, consider this example: If you put in $5,500 per year (the new IRA maximum) for 30 years to a hypothetical investment that earned 7 percent a year, but on which you paid taxes every year (at the 25 percent tax bracket), you’d end up with slightly more than $401,000 - about $155,000 less than what you’d accumulate in an IRA. As mentioned above, you will eventually have to pay taxes on your traditional IRA withdrawals, but by the time you do, you might be in a lower tax bracket. Furthermore, depending on your income level, some of your contributions to a traditional IRA may be tax-deductible. (Roth IRA contributions are not deductible.)
Variety of investment options - You can invest your funds within your IRA in many types of investments - stocks, bonds, certificates of deposit (CDs), U.S. Treasury securities and so on. In fact, within your IRA, you can create a mix of investments that are suitable for your risk tolerance, time horizon and long-term goals. Of course, investing always carries some risks, including loss of principal - but the risk of not investing may be greater, in terms of not having enough assets for retirement.
Here’s one more point to keep in mind: The earlier in the year you “max out” on your IRA contributions, the more time you’ll give your account to potentially grow. By reaching the new, higher contribution limits, and by fully funding your IRA as early in each year as possible, you can help yourself take full advantage of this powerful retirement savings tool.
Brian Humphrey is a financial consultant and investment advisor.