If you’re saving in an IRA, you’re already doing your part to secure a financially sound retirement. And if you’re retired with an IRA, you no doubt know what a critical role that account plays in helping you manage your finances. That said, there are steps you can take to help ensure that your IRA serves you well both at present as well as in the future. Here are three to focus on.
1. Max out
The more you’re able to contribute to your IRA, the more money you stand to retire with. But maxing out your IRA can also have a huge impact on your present-day finances, provided you’re saving in a traditional account as opposed to a Roth. That’s because traditional IRA contributions can be deducted from your taxes so that you’re paying the IRS less money any time you fund your account.
Currently, the maximum annual contribution for an IRA is $5,500 if you’re under 50, or $6,500 if you’re 50 or older. So what does that mean for your taxes? Let’s assume you’re 40 and hit the $5,500 max. If your effective tax rate is 25%, you’ll shave $1,375 off of your 2018 tax bill by diverting as much money as possible to a traditional IRA. And that’s not a bad deal.
Furthermore, maxing out your IRA on a yearly basis could work wonders for your nest egg over time. Let’s assume that the annual contribution limits won’t change over the next 30 years (an unlikely scenario, but let’s run with it). If you’re 40 and contribute $3,600 annually to your IRA between now and age 70, you’ll wind up with $340,000, assuming your investments generate an average annual 7% return during that time. However, if you max out at $5,500 for the next 10 years, and then at $6,500 for the following 20, you’ll retire with over $560,000. Talk about a game-changer. And that’s precisely why it pays to max out your IRA this year — to get the ball rolling on a very wise habit.
2. Take advantage of catch-up contributions
The average IRA balance reached $106,000 earlier this year, according to Fidelity Investments. Now, if you’re 35 with that amount of cash socked away, you’re in pretty good shape. But if you’re 55, you have some catching up to do — in which case it pays to take advantage of that $1,000 catch-up contribution.
Let’s assume you’re 55 with $106,000 in savings and your goal is to retire at 70. Let’s also assume that you’re currently saving $5,500 a year. If you continue on that road for 15 more years, your IRA balance will grow to about $431,000, assuming the average annual 7% return we implemented above. But if you increase your yearly contributions to $6,500, you’ll retire with closer to $456,000. And make no mistake about it: That extra $25,000 will come in quite handy when you’re older and limited to a fixed income.
3. Take your RMD
Unless you have a Roth account, the money in your IRA can’t just sit there forever. Rather, you’re forced to take required minimum distributions, or RMDs, every year beginning the year after you turn 70 1/2.
Your yearly RMD will be a function of your account balance coupled with your life expectancy, and unfortunately, once you withdraw funds from your traditional IRA, you’ll be on the hook for taxes on whatever sum you remove. Failing to take that RMD, however, comes with an even worse consequence — a 50% penalty on the amount you neglect to remove. This means that if you’re looking at an RMD of $8,000 and you don’t take it in time, you’ll lose $4,000 off the bat. Ouch.
That’s why you must make sure to take your RMD before you run out of time. You have until Dec. 31 of this year to complete your 2018 RMD, so if you’re worried you’ll get busy around the holidays and forget, withdraw those funds now.
Your IRA can help your finances immensely both now and in the future. And if you’re smart about managing it, it’ll do just that.