The amount of money you can contribute to a tax-advantaged retirement plan like an IRA or 401(k) isn't set in stone. Rather, the IRS can adjust those annual limits to account for inflation.
In 2019, savers under 50 can contribute up to $19,000 to a 401(k) plan, while those 50 and over can contribute up to $25,000 thanks to a $6,000 catch-up provision. In 2020, workers under 50 will get to contribute up to $19,500 to a 401(k), while those 50 and over will get a $6,500 catch-up that raises their maximum to $26,000.
IRA limits, however, aren't increasing for 2020, which means the current maximums will stay in play: $6,000 for workers under 50, and $7,000 for those 50 and over, which includes a $1,000 catch-up.
Clearly, these limits fall well below the maximum for 401(k)s, which makes hitting them more feasible. And no matter how many years away from retirement you are, it pays to aim to max out your IRA in 2020.
The upside of funding an IRA
Whether you opt for a traditional IRA or a Roth IRA, the annual contribution limits are still the same. And both accounts offer tax benefits it pays to capitalize on, though you should know that if you're a higher earner, you won't get the option to fund a Roth IRA directly. If you're an individual tax filer earning over $139,000, Roth contributions are off the table. The same holds true if you're a married couple filing jointly with an income in excess of $206,000.
But let's get back to those tax benefits. With a traditional IRA, the money you contribute goes in on a tax-free basis, which means you lower your IRS burden instantly. Let's imagine you're 42 and max out your traditional IRA next year. If you're in the 24% tax bracket, that $6,000 contribution saves you $1,440 in taxes. Furthermore, the money in your traditional IRA gets to grow on a tax-deferred basis, and you'll only be taxed on that account once you take withdrawals in retirement. That's important, because the gains you snag by investing your IRA won't be taxable year over year. As such, you can reinvest them for added growth.
Roth IRAs have the opposite setup of traditional IRAs. Contributions go in on an after-tax basis, so there's no immediate IRS break for funding an account. But once you invest those funds, your money gets to grow on a completely tax-free basis, and withdrawals aren't taxed during retirement. That buys you a lot more flexibility later in life, when you're on a fixed income.
But tax benefits aside, maxing out an IRA helps ensure that you have enough money to support yourself once you stop working full-time. Most seniors need about 80% of their former income to maintain a comfortable lifestyle in retirement, and Social Security will, for the average earner, provide about half that sum. The rest, therefore, needs to come from another source, and if you don't have a pension (which is the case for a large percentage of workers today), personal savings are your next best bet.
Now it's a good idea to max out your IRA year after year. But even if you only manage to max yours out in 2020 at $6,000, if you then keep that money invested for another 45 years, you'll have $126,000 on hand for retirement, assuming your IRA generates an average annual 7% return (which is a couple of percentage points below the stock market's average). So cut expenses in your budget, get yourself a side job to generate more income, and do whatever it takes to contribute as much as the IRS allows to an IRA next year. You'll be thankful you did in the long run.