Contribution Limits on Retirement Investments
The increasing attention paid towards savings for retirement or other significant savings goals, such as a child’s college education, warrants the need for elementary knowledge of the monetary limits set by the Internal Revenue Service (IRS). These contribution limits impose a standard to the investment holder of a certain amount, which cannot be exceeded within a given year without penalty. The IRS evaluates these contribution limit values each year, periodically adjusting for cost of living and inflation.
Let’s examine the most common investment accounts and the related contribution limitations for each:
401(k) Retirement Savings Plan
A 401(k) retirement savings plan, offered through an employer as a deduction of a paycheck to invest in retirement savings, is offered in two major types – Traditional and Roth. The difference hinges on when the funds are taxed and able to be withdrawn. In a Traditional 401(k), the investment amount is deducted from each paycheck, taxed upon withdrawal and limited to access until age 59 ½ or penalized at 10% of the amount of the savings in addition to the normal taxes imposed on the beneficiary. Roth 401(k)s receive taxed contributions, thus allowing the beneficiary to receive these funds tax-free upon withdrawal as soon as five years after establishment.
Both 401(k) types are limited to a set amount of elective salary deferral (that is, the amount chosen by the beneficiary to contribute into the retirement savings plan), though also offer limited additional ‘catch-up’ contributions for age 50 and older. This limit applies to all 401(k) accounts within a designated year; if, for instance, an individual holds more than one job or switches jobs in the middle of the year, the contribution limit is still imposed.
Traditional and Roth Individual Retirement Accounts
Individual Retirement Accounts (IRA’s) differ from 401(k) plans based on the management of funds: whereas 401(k) savings plans run through the employer or their chosen financial investment manager, IRA savings accounts are initiated by the beneficiary, serving as a savings account managed either directly or indirectly by the individual. These retirement savings options may be contributed in addition to a 401(k) offered through an employer, and those filing joint returns are allowed to make contributions to an IRA even if only one spouse has taxable compensation within the year.
Anyone with earned income younger than 70 ½ years old can contribute to a Traditional IRA, whereas Roth IRA accounts have limitations based on a modified adjusted gross income calculation (earned income less certain adjustments). Similar to Traditional and Roth 401(k)s, the former is taxed upon withdrawal while the latter is taxed prior to contribution. Withdrawals are mandated with Traditional IRAs in the form of minimum distributions at age 70 ½; Roth IRAs do not mandate withdrawals at any point, though limit withdrawals on earnings to five years after establishment and age 59 ½.