The maximum that most people can contribute to an individual retirement account, or IRA, in 2018 is $5,500. While this may seem like a lot of money to set aside, it could be a small price to pay for the long-term financial security it can buy you. Here's a look at what maxing out your IRA contribution now can do for your retirement nest egg.
The 2018 IRA contribution limits
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For 2018, individuals can contribute as much as $5,500 to an IRA, provided they have earned income that is at least as much as their contribution. Individuals who will be 50 or older by the end of 2018 can contribute an additional $1,000, for a total maximum of $6,500.
Contributions to an IRA for the 2018 tax year can be made from Jan. 1, 2018, through Tax Day 2019, April 15, 2019. Similarly, 2017 IRA contributions can be made until Tax Day 2018, April 17.
It's also important to mention that this limit is per person, not per account. In other words, if you have two IRAs -- say, a traditional and a Roth -- your total contributions cannot exceed your annual limit.
How much could this grow to by retirement?
If you allocate your IRA funds properly in a combination of stock and bond investments, it's reasonable to expect annualized returns of about 7% from your IRA over the long run. While this is certainly not guaranteed, here's how much a maxed-out IRA contribution could grow to over certain periods of time.
Don't forget the tax benefits
In addition to the growth potential of a maxed-out IRA contribution, it's also important to consider the tax advantages.
If you contribute to a traditional IRA and qualify for an IRA tax deduction, you can deduct your contribution from your 2018 adjusted gross income (AGI). The tax savings this can produce depends on your marginal tax bracket, but just as an example, if you are in the 25% tax bracket and contribute $5,500 to a traditional IRA in 2018, you could reduce your 2018 tax bill by $1,375.
On the other hand, if you qualify for and contribute to a Roth IRA in 2018, you cannot deduct your contributions on your 2018 tax return. However, your qualified withdrawals from the account, presumably once you retire, will be 100% tax-free. So in the hypothetical case in the preceding chart, where you contribute $5,500 to an IRA and it balloons to $58,721 over a 35-year period, your investment earnings of more than $53,000 won't cost you a dime in taxes.
The fun part: What if you max out your IRA every year?
So far, we've looked at what could happen if you max out your IRA in 2018. However, the point of an IRA is to contribute to it steadily, year after year, to build a retirement nest egg.
With this in mind, let's say you contribute $5,500 to an IRA every year between now and when you retire. Here's what this could mean, assuming 7% average long-term investment returns.
Inflation is a two-way street
You may be thinking something like "Yeah, but in 30 years, $519,534 isn't going to be worth nearly as much as it is today." And that's very true. In fact, based on the historic average inflation rate of about 3%, $519,534 will have about $208,000 in purchasing power, in terms of today's dollars.
However, keep in mind that this example is based on an ongoing contribution of $5,500 per year. And by the same logic, $5,500 in 30 years won't be the same as $5,500 today.
In reality, the annual IRA contribution limit changes over time to keep up with inflation, and if you max out your IRA contribution every year, it should help combat the effects of inflation over time. For example, if the 2019 IRA contribution limit is raised to $6,000, you'll then contribute that amount, and so on in subsequent years.
The smartest tax move you can make?
If you qualify to take advantage of an IRA and its tax benefits, it has two very important personal finance effects, making it unique among tax strategies. Not only do you qualify for a valuable tax break, either every year you contribute or later on when you withdraw your money, but you also will be building up a retirement nest egg and supplying yourself with long-term financial freedom in the process. It is because of this combination of benefits that I've referred to retirement saving as the hands-down best tax move that most Americans can make.
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