One of the best ways to save for retirement is via a qualified retirement account. Such accounts are tax advantaged: contributions to these accounts are usually tax-deductible, and the accounts will grow tax-free during your working years, at rates that will vary depending on the asset mix held by the account. It is only when you begin withdrawing money from the account, in your retirement, that taxes become due, on the amount withdrawn. Other qualified retirement accounts (Roth Individual Retirement Accounts, or IRAs) do not offer tax-deductible contributions, but all withdrawals are completely free of tax.
Given these generous advantages offered by retirement accounts, you may be asking, how much money should I save per month? Unfortunately, given that the federal government loses revenue on such accounts, the IRS imposes limits on how much you can contribute annually. We need to be aware of such retirement laws, as over contributions may involve penalties.
Tax Advantage for 401(k) and Maximum Contribution
The most popular tax-advantaged retirement account is the 401(k), a defined-contribution plan offered by many employers that encourages employees to save up for retirement. The maximum annual contribution that you can make to a 401(k) account changes every year; in 2011, the total allowable contribution is $16,500, and in 2012 the limit will be $17,000. If you have two separate 401(k)s with two different employers, the sum total that you can contribute to both accounts is the same — $16,500 in 2011 and $17,000 in 2012. If you contribute $14,000 to one of your 401(k)s in 2011, you can then contribute only $2,500 to the other. Discuss your limits with your employer; if you set up automatic paycheck deductions, your employer should inform you of your limits.
These limits apply to your own contributions only. If your employer offers matching contributions to your 401(k) account, these will be above and beyond the $16,500 you have already contributed in 2011. It’s a good idea to contribute as much as you can on your own, to become eligible for the maximum employer matching contributions available to you. Also, if you’re 50 years of age or older, you are eligible to make “catch-up” contributions of $5,500 (in 2011 and 2012). Catch-up contributions are intended to benefit employees who may have contributed less than they should have earlier in their careers, allowing them to save substantial sums tax-free in their later working years. However, even if you’ve saved diligently and have a sufficient nest egg already, you can still make catch-up contributions and save even more.
Tax Advantage for IRA Accounts and Maximum Contribution
Individual savers with additional money to put away can open IRA accounts on their own, apart from their 401(k) accounts. Contributions to regular IRA accounts are tax-deductible, but withdrawals are subject to tax; contributions to Roth IRAs, on the other hand, are NOT tax-deductible, but withdrawals are entirely tax-free. However, as with 401(k)s, there are limits as to how much you can contribute each year. In 2011 and 2012, savers aged 49 and below could contributed a maximum of $5,000 to either a regular or a Roth IRA account; for those age 50 and above, the limit is $6,000. Note that a contribution cannot be larger than one’s taxable compensation for the year; if a 38-year-old takes most of the year off and earns only $3,500 during the whole year, that becomes his maximum allowable contribution. Also, there is no carry-over to the next year; the same 38-year-old could not contribute $6,500 the following year, but would be limited to the annual $5,000 contribution.
When you’re thinking through your plan to retire, it’s important to save as much money as you can to ensure a comfortable retirement, but it’s also important to stick to the contribution limits for money you’re putting into tax-advantaged retirement accounts.