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As it does every year, the IRS recently announced contribution and deduction limits to Americans’ retirement accounts for 2020. While the limits for Roth and traditional IRAs remain unchanged from 2019, it’s still a good idea to review what these limits mean and how to best maximize your retirement savings without giving an unnecessary cut to Uncle Sam.
IRAs differ from 401(k) plans in a number of ways, but the most significant difference is the contribution limits. While 401(k) participants can contribute a healthy $19,500 per year to their retirement vehicle, IRA holders face much lower limits. What determines how much you can contribute? Your age, marital status and modified adjusted gross income (MAGI) will tell the tale.
IRA Contribution Limits
Not everyone is allowed to contribute the same amount to their IRA. In fact, much high income earned isn’t eligible to contribute to a Roth IRA at all. However, no income limits exist for traditional IRAs, only deduction restrictions. But regardless of your status, contributions are limited compared to retirement vehicles like the 401(k). The federal government has left IRA contribution rates unchanged for 2020, which means:
- $6,000 maximum contribution if you’re under 50
- $7,000 maximum contribution if you’re 50 or older
Participants older than 50 are allowed to make “catch up” contributions since mandatory distributions begin at 70 ½. (Yes, some government economists are strange.)
Remember, contributions can be made to a traditional IRA regardless of your level of income. An employee making $30,000 can only contribute $6,000 in 2020, the same as an employee at the same company making $200,000. But here’s the kicker — IRA contributions are tax-deductible depending on your salary and whether you already participate in a 401(k) or other qualified retirement accounts.
|Status||Modified AGI||Tax Deduction Eligibility|
|Single||Less than $65,000||Can make full deduction|
|Btwn $65,000 and $75,000||Can make partial deduction|
|Over $75,000||Ineligible for deduction|
|Married filing jointly||Less than $104,000||Can make full deduction|
|Btwn $104,000 and $124,000||Can make partial deduction|
|Over $124,000||Ineligible for deduction|
|Married filing separately (with spouse covered by a work plan)||Less than $10,000||Can make partial deduction|
|Over $10,000||Ineligible for deduction|
Important note: If neither you or your spouse have a work-sponsored plan like a 401(k) and only contribute to a traditional IRA, your contribution will be completely tax-deductible regardless of your income. If either you OR your spouse is covered by a work plan, your modified AGI will determine the amount you can deduct.
IRA Contribution Exceptions
As always, exceptions to the rules apply. Make sure to understand these exceptions before filing your tax return.
- Earned income rules: Only earned income counts towards IRA contribution limits. Earned income means taxable compensation like wages, commissions, bonuses, and self-employed income. Income from rental properties, stock sales, or pensions and annuities does NOT apply.
- Must earn income above contribution level: The $6,000 maximum contribution only applies if you earned at least $6,000 in taxable compensation during the year. If you made less than $6,000 in the calendar year, you can only contribute up to that level of earned income. For example, a part-time worker earning $4,500 annually can only contribute up to $4,500 in a traditional IRA. You must make at least $6,000 to make the full contribution.
- Spousal IRAs: If you’re married and file jointly, you can still contribute to an IRA even if you have no earned income. Married nonworking individuals can use their spouse’s income to meet the taxable compensation rules and open a traditional IRA. As long as your spouse makes at least $12,000 annually, you each could contribute $6,000 to an IRA.
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Should You Contribute to a Roth IRA or Traditional IRA?
The Roth IRA has a number of advantages over the traditional IRA, especially if you’re already contributing to a 401(k). Tax deferments are the biggest difference — Roth IRA taxes are paid upfront while traditional IRAs are taxed at withdrawal. But if you’re already contributing to a 401(k), your tax deductions on a traditional IRA will be limited based on your income. Plus you’ll be getting no tax diversification. Roth IRAs also have no mandatory distribution age and much more lenient rules on early withdrawals. Consider the following if you’re debating Roth IRA vs. traditional IRA:
- You should open a traditional IRA if:
- You have no 401(k) from work.
- You expect to be in a lower tax bracket at retirement.
- You have no plans to tap it before age 59 ½.
- Your modified AGI is more than $139,000 annually (or more than $206,000 if married and filing jointly).
- You should open a Roth IRA if:
- You have a 401(k) already.
- You expect to be in the same tax bracket at retirement.
- You want flexibility on distributions.
- Your modified AGI is less than $139,000 annually (or less than $206,000 if married and filing jointly).
What if You Want to Contribute Past the Limit?
Contributing more than $6,000 to a traditional IRA might leave you susceptible to stiff penalties that eradicate your benefits. Any “extra” contributions (and their earnings) will be hit with a 6% tax each year. If you notice you’ve contributed too much and have already filed your taxes, you can still amend your return by October 15th — just make sure to take out excess cash first!
If you want to contribute more than $6,000 to a traditional IRA, you’re out of luck. However, you can still stash more money away with different retirement vehicles.
|Account Type||2021 Contribution Limit|
|401(k) and 403(b) employer-sponsored plans||$19,500 ($26,000 if over age 50)|
|Simplified Employee Pension (SEP) IRA||25% of income or $57,000|
|Savings Incentive Match Plan for Employees (SIMPLE) IRA||$13,500 ($16,500 if over age 50)|
If you don’t qualify for anything beyond the traditional or Roth IRA, you still have options.
Health savings accounts (HSAs) are tax-deferred savings vehicles for people and families who meet minimum insurance deductibles. HSA funds can only be used only for qualified medical expenses until age 65, but no restrictions apply after that.
529 Plans are tax-deferred savings vehicles for qualified education expenses. If you’re a parent and plan on sending kids to college someday, a 529 plan is a great way to get additional tax benefits on investment savings.
And don’t forget, a good old standard brokerage account is still better than a bank account or CD!
How to Find an IRA that Works for You
Finding the proper IRA takes a little bit of self-evaluation. You don’t necessarily need the help of a CFP®, but you’ll need to consider your financial situation both now and in the future. How much do you want to save? What other investment vehicles do you contribute to? If you already have a 401(k) from work and don’t make enough to disqualify you from a Roth IRA, open a Roth. You’ll get better tax treatment and fewer restrictions.
If you don’t have a work-sponsored plan, a traditional IRA is your top option for building retirement savings. Most brokerages offer IRAs with no fees or a minimum deposit to open. Roth IRA vs. traditional IRA isn’t the important debate here. If you contribute early and often to either plan, you’ll be well ahead of your peers financially.