Surprisingly, not everyone saves for retirement. And even some who do may not have enough money to retire comfortably.
If you haven't saved enough, an individual retirement account (IRA) may benefit you, especially since the IRS increased the 2019 IRA contribution limits. This change could help you save more for retirement, which may go a long way toward securing your financial future.
What Is an IRA?
An IRA is an account that offers tax benefits to help you save for retirement. Similar to a 401(k) through your employer, an IRA is intended to help you grow your retirement income.
However, you can open an IRA on your own through a bank or financial services company. There are several types of IRAs such as traditional IRAs, in which you invest pre-tax dollars, and Roth IRAs, in which you invest after-tax dollars. Some IRAs also have certain tax advantages. For example, money invested in a traditional IRA grows tax-free and is only taxed when you withdraw it. Depending on your tax filing status and income, your contributions also may be tax-deductible.
What Are the 2020 IRA Contribution Limits?
The IRS limits the amount you can contribute to an IRA each year. Since 2013, the annual IRA contribution limit has been $5,500 for those under age 50.
However, in late 2018 the IRS announced cost-of-living adjustments to this number. Starting in the 2019 tax year, people under age 50 now can contribute up to $6,000 a year to an IRA — a $500 increase. If you're age 50 or older, you can make an additional catch-up contribution of $1,000 (this number hasn't changed from previous years). These contribution limits remain the same for 2020.
The amount you can contribute to a Roth IRA varies according to your income and filing status. For example, if you're single and make more than $122,000, your AGI (adjusted gross income) is between $124,000 and $139,000 in 2020, you only can contribute a reduced amount to an IRA.
How These Changes Could Affect Your Retirement Plan
Though a $500 increase to the IRA contribution limit may seem like a small change, it adds up over time. That additional contribution could end up being a lot of money in the future, especially if you open an IRA in your 20s and continue to invest part of your income over the next 30 or 40 years.
Thanks to compound interest, which is the interest you earn on interest, saving early and often could be the difference between a comfortable retirement and a financially tight one. And if your income tax rate will be lower in retirement — as it likely will be for many people who no longer have a regular income after they stop working — you may be able to keep more of the money you've saved.
The bottom line is that investing that extra $500 every year could be an effective way to put your money to work for you. The interest you earn on this extra money could bring you closer to your retirement savings goal and help you enjoy the quality of life in retirement you've worked year in and year out to achieve.