During the recent recession did you continue to max out contributions to your individual retirement account (IRA) year in and year out? Or, were you like me — performing financial triage to survive the hard times and forgetting about savings, for the duration?
Well, fortunately, one of the beauties of an IRA is a rule that gives those of us who are 50 or older a second chance. We can make “catch-up” contributions to our IRAs that may compensate for our losses in the down years.
In the following IRA contribution tips, you’ll see how catch-up contributions and other advantages offered by IRAs make them flexible and friendly tools for retirement investments.
IRA catch-up contributions defined
The catch-up contribution to your traditional IRA essentially allows you to increase your IRA contribution from the standard annual contribution limit of $5,500 and invest an additional $1,100 each year in your IRA.
So, those 50 and older, are allowed to contribute a total of $6,600 into their IRA accounts if you have at least that much in taxable income. If you’re married, this means a total of $13,200 in retirement savings that you and your spouse can contribute to your combined IRA accounts each year.
The difference catch-up contributions can make
Now, an extra $1,100 may not sound like it would make all that much of a difference. But, if you take into account the benefits of compounding interest over time, it will continue to grow exponentially. And in twenty years that extra $1,100, for example, can grow into an additional $45,000 or so for your retirement nest egg.
That amount translates into an increase in your standard of living during retirement by some $150 per month — if you use the standard annual withdrawal rate during retirement of 4 percent that most financial planners recommend.
If you and your spouse both have IRAs that you can maximize with catch up contributions, together you double your investment to $2,200 annually — and gain more than $300 per month in retirement.
Making the most of IRA advantages
Most investors are very familiar with the tax advantages of an IRA. Catch-up contributions allow investors to increase their investment and ultimately have a larger account balance to withdraw from in retirement when principle, earnings, and interest will be taxed at a lower rate. If you are old enough to qualify for the catch-up contributions option, maximizing your IRA can be a great approach to tax planning as well as retirement investing (different tax rules apply to Roth IRAs).
IRAs also allow you to pass on your investments to an heir should you die before receiving distributions. Catch-up contributions allow older investors to capitalize on IRAs incredible benefits with additional funds. These seemingly minor $1,100 in extra catch-up contributions can grow tax free for many years before investors use them in retirement.
If you are looking for a way to boost your IRA contributions, but found you have reached your limit, another of my IRA contribution tips is a suggestion to open an IRA for your non-working spouse. This method is one of the tax exceptions to the “earned income” rule that accompanies opening an IRA.
Opening a spousal IRA
When you open a spousal IRA, it is in your partner’s name, so it restarts the contribution limits for the IRA. If you have already maxed out your own IRA contributions, this can be a great opportunity for you to enhance your tax-advantaged retirement planning.
To utilize this doubling up of IRA contributions, you cannot have a joint IRA. You have to set up the IRA separately for your non-working spouse. This means that the IRA is set up in your partner’s name and social security number. With this set up, you can contribute $5,500 for your IRA and $5,500 for your spouse’s, resulting in a yearly contribution of $11,000. (Remember also that contribution limits may rise in future years, along with inflation.)
You can be named the beneficiary of the IRA, but once you start contributing to the account, keep in mind the money belongs in your spouse’s account. This is important in the event that divorce could be in your future. When you are earning income, it is possible for you to make a spousal contribution to an IRA in the name of your partner. In order to take advantage of this situation, though, you have to be married, and your tax filing status must be “married filing jointly.” You cannot make a spousal contribution to an IRA if you are filing separately.
You get your immediate tax deduction for making a contribution to your non-working spouse’s IRA. You are also subject to the income phase outs that come with contributions to a IRA. Required minimum withdrawals for IRAs start at age 70 1/2, and you have to be age 59 1/2 to begin taking non-qualified distributions penalty-free from an IRA. Make sure you understand IRA rules before opening this type of account for your spouse.
Smoothing the path to retirement
Providing spousal contributions to an IRA in your partner’s name can be a good way to boost your tax-advantaged income savings if you only have one income for your household. Additionally, it can be a way to provide a measure of financial security for a spouse who’s contributing a great deal of work to your joint success — but who may not be financially compensated.
To better prepare for the future and ease the way to retirement, take full advantage of these IRA contribution tips. Catch-up contributions and spousal contributions are great ways to maximize the potential of your IRAs. You’ll increase your household savings, spend less on taxes, and embark on retirement with a smile.
Jeff is a licensed real estate agent in California and he specializes in home buying, mortgages, and debt, among other money topics. His work has appeared in Business Insider and Trulia.