An individual retirement account (IRA) can be a useful tool for retirement planning. You can open an IRA and contribute funds in addition to the money you’re saving in your 401k at work or as a replacement for a 401k if you don’t have a workplace retirement plan. As for how to contribute to IRA plans, you have different options for funding them. It’s also important to understand the IRS rules for making contributions annually. A financial advisor can help you make the most of your IRA.
What Is an IRA?
An IRA is a tax-advantaged retirement account that can be opened through a bank, online brokerage or other financial institution. IRAs allow you to save money for retirement, up to the annual contribution limits, then withdraw that money later when you retire.
There are two basic types of IRA: Traditional and Roth. Traditional IRAs can allow for tax-deductible contributions and qualified withdrawals are taxed as ordinary income. Roth IRAs don’t offer any type of deduction for contributions but qualified withdrawals are 100% tax-free. A Roth offers the additional advantage of being able to withdraw original contributions at any time without a tax penalty since these accounts are funded with after-tax dollars.
The IRS sets annual contribution limits for IRAs and adjusts them periodically for inflation. For 2021 and 2022, the maximum contribution is $6,000. A catch-up contribution of $1,000 is allowed for people aged 50 and older. These are cumulative limits, meaning that if you have multiple IRAs, your total contributions can’t exceed $6,000 for the year (or $7,000 if you qualify).
Can I Contribute to My Own IRA?
IRA plans are funded by the individuals that own them. An IRA is not the same thing as a 401k plan, which is a qualified plan offered by private employers to employees. If you open an IRA, you’re responsible for funding it; there are no matching contributions made by an employer. SEP IRAs and SIMPLE IRAs are exceptions to this rule.
Simplified Employee Pensions and Savings Incentive Match Plans for Employees are designed for small business owners and self-employed individuals. These plans allow for both employer and employee contributions. SEP IRAs and SIMPLE IRAs follow different annual contribution limits than traditional and Roth IRAs. But in terms of taxation for qualified withdrawals, they follow the same tax rules as traditional IRAs.
One thing to note about Roth IRAs is that not everyone can contribute. Your ability to open and fund a Roth IRA is determined by your income and filing status. If you’re hoping to fund a Roth IRA in 2022, here’s what the income phaseout ranges look like:
- $129,000 to $144,000 – Single taxpayers and heads of household
- $204,000 to $214,000- Married, filing jointly
- $0 to $10,000 – Married, filing separately
That means if you’re single and have a modified adjusted gross income of $145,000 then you wouldn’t be able to contribute to a Roth IRA. High-income earners may, however, be able to do so using a Roth conversion or backdoor Roth IRA. This involves converting funds from a traditional IRA to a Roth, which means paying taxes on the conversion.
How to Contribute to IRA Plans
If you have an IRA, the institution that holds it for you may offer multiple ways to fund it. The most common options for making IRA contributions are ACH transfers from a linked bank account or mailing in a check. Between the two, ACH transfers can be the faster option as they can be completed within a few business days. Checks, on the other hand, can take days or even weeks to arrive and clear.
Contributing to an IRA via bank transfer is a relatively simple process. Here are the steps required:
- Log in to your IRA account online.
- Navigate to the section of the menu designated for making contributions.
- Select the dollar amount of the contribution you’d like to make and the tax year you’re making the contribution for.
- Select the investment options for the funds.
- Choose your linked bank account from which to transfer funds.
- Review the details of the transaction and submit the request.
It may take up to five business days for the transfer request to be completed, though you may see the transfer amount listed as pending in your IRA dashboard right away. You can schedule a one-time transfer or set up recurring transfers if you’d like to automate your investment strategy.
If you’d rather send in a check instead, your bank or brokerage should be able to provide you with the correct mailing address. You’d need to write your account number on the check so that the amount can be properly credited.
Scheduling an electronic transfer or writing a check are both simple ways to add money to an IRA. An IRA rollover is a third option. A rollover simply involves taking money from one qualified retirement plan and moving it over to your IRA.
For example, say you change jobs and you have a 401k plan with your previous employer. If you’d like to consolidate your retirement accounts, you could roll the money from the 401k into your IRA. Choosing a direct rollover option is usually best, as it can allow you to avoid any unexpected tax penalties. Direct rollovers mean the money is transferred directly from plan to plan, instead of being transferred to you first.
How to Find the Money to Contribute to an IRA
The question of how to contribute to IRA plans has another dimension, as it’s important to consider where the money you invest will actually come from. You could make recurring deposits each payday but there are a few possibilities for supplementing the money that you save. For example, if you typically get a tax refund you could use that money to fund your IRA. In fact, the IRS allows you to direct deposit part or all of your refund into an IRA. This way, there’s no temptation to spend the money before it makes its way into your retirement account.
You can also leverage tax benefits to find the money to contribute to your account. The Retirement Saver’s Credit can offer tax savings, which you could use to add to your IRA. Tax credits reduce your tax liability on a dollar-for-dollar basis. This credit could pay you back up to 50% on a traditional IRA contribution of $2,000 (or $4,000 if you’re married). Eligibility is based on income and filing status. Here’s how the numbers add up for claiming the credit in 2022.
2022 Saver’s Credit Income Limits
|Credit Amount||Single||Head of Household||Joint Filers|
|50% of contribution||AGI of $20,500 or less||AGI of $30,750 or less||AGI of $40,000 or less|
|20% of contribution||$20,501 – $22,000||$30,751 – $33,000||$41,001 – $44,000|
|10% of contribution||$22,001 – $34,000||$33,001 – $51,000||$44,001 – $68,000|
|0% of contribution||more than $34,000||more than $51,000||more than $68,000|
Remember that you may also be able to deduct the money you put into a traditional IRA. Deductions reduce your taxable income for the year, which could mean a bigger refund that you could use to fund your retirement savings. Whether you’re eligible for a full deduction is determined by your income, marital status and whether you or your spouse are covered by a retirement plan at work.
- Single filers who are covered by a plan at work can claim the full deduction if their modified adjusted gross income is less $66,000 for 2021 and less than $68,000 for 2022.
- If you’re married, file jointly and are covered by a plan at work, you can claim the full deduction if your modified adjusted gross income is less than $105,000 for 2021 and less than $109,000 for 2022.
- If you’re married, file jointly and your spouse is covered by a plan at work, you can claim the full deduction if your modified adjusted gross income is less than $198,000 for 2021 or less tan $204,000 for 2022.
Once your income passes those thresholds, the deduction begins to phase out until it disappears altogether.
The Bottom Line
An IRA can help you to get on track with your retirement goals. Knowing how to contribute to IRA plans is the first step. The next is committing to saving regularly so that you can use the power of compounding interest to grow wealth over the long term.
Retirement Planning Tips
- In addition to saving in an IRA, you could also open an online brokerage account to invest for retirement. The difference between a taxable brokerage account and an IRA is that you’ll owe capital gains tax when you sell investments at a profit. A brokerage account is worth considering if you’d like a wider range of investment options than what your IRA offers. For example, you might be able to trade stocks and ETFs commission-free, while also investing in cryptocurrency or IPOs.
- Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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