Once your last-minute holiday shopping is finally over and all your gifts are accounted for, there’s still one person we often tend to overlook: ourselves.
If you have some extra cash left over and are looking for ways to spend it mindfully before the new year, why not consider investing in an IRA? Not only would you be doing your future self a favor, but you might even be able to gift yourself a tax break next year in the process!
What is an IRA?
IRA stands for Individual Retirement Account. By opening and contributing to an IRA, you are funding an investment account with the purpose of building yourself a nest egg for retirement. IRAs are typically the main source of retirement savings for people who are self-employed or those who don’t otherwise have a work retirement plan such as a 401(k).
However, even if you do have a 401(k) plan through work, an IRA may still be a helpful retirement savings option for you! The great thing about IRAs is the account is in your name — it’s not tied to your job — and you have full control over how you want to invest your money. An IRA is also a great way to rollover and consolidate any old 401(k) accounts you may still have from previous jobs.
These are the two main kinds of IRAs: traditional and Roth. We’ll discuss some of their differences below, but we will mainly be looking at traditional IRA accounts.
How much can I contribute to my IRA each year?
Contribution limits change every few years, but for 2021 and 2022, you can contribute up to $6,000 per year to your IRA account (or up to $7,000 if you are age 50 or older).
One notable exception is your annual contributions cannot exceed your annual income. For example, if your total income for 2021 was $4,000, your IRA contribution limit would also be $4,000.
There are additional exceptions for married non-working spouses. If you or your spouse earns taxable compensation while the other does not work, you can both still save for retirement by opening a spousal IRA.
Are IRA contributions tax-deductible?
Yes, they can be! The deductibility of IRA contributions depends on which type of IRA you have:
- Traditional IRA contributions are tax-deductible based on whether you meet certain criteria.
- Roth IRA contributions are not tax-deductible. This is because you pay income taxes upfront when you contribute to a Roth IRA.
The deduction of IRA contributions is considered an above-the-line deduction, meaning you can claim this tax credit regardless of whether you take the standard or itemized deduction on your tax return. You can only deduct contributions in the year they are made and doing so will reduce your taxable income.
Qualifying for the deduction of traditional IRA contributions can depend on a few different factors. If you do not have a work retirement plan (and your spouse also doesn’t have one, if you’re married) then you both automatically qualify to deduct your traditional IRA contributions on your tax return.
If you or your spouse do have a retirement plan through work, the IRS looks at your modified adjusted gross income (MAGI) to determine if you qualify for a tax deduction. If your MAGI is less than the IRS’s “phaseout” limits, you qualify for the full deduction. If your AGI is over that limit, you are eligible for a partial deduction until you reach the IRS’s maximum income limit. If your MAGI exceeds the maximum limit, you will not qualify for a deduction.
Here are some examples of the current MAGI limits for 2021:
- If you are a single or head-of-household filer and have a retirement plan through work, you qualify for a full deduction if you make $66,000 or less per year. After that, you can receive a partial deduction if your total MAGI is below $76,000. If your income is $76,000 or more, you will not qualify for a deduction.
- If you are married and filing jointly with a spouse who IS covered through work and you are NOT, you qualify for a full deduction if you make $198,000 or less per year. After that, you can receive a partial deduction if your total MAGI is below $208,000. If your income is $208,000 or more, you will not qualify for a deduction.
- If you are married and filing jointly and you both have retirement plans through work, you qualify for a full deduction if you make $105,000 or less per year. After that, you can receive a partial deduction if your total MAGI is below $125,000. If your income is $125,000 or more, you will not qualify for a deduction.
The IRS can change its MAGI limitations each year depending on inflation. To view all of the current 2021 IRA deduction limits, check this page if you are NOT covered by a work retirement plan and this page if you ARE covered by a work retirement plan.
Can I make a gift contribution to someone else’s IRA?
Yes, but there are certain requirements for doing so. If you want to give someone else the gift of tax-free retirement savings, you still need to heed the IRS’s contribution limits.
For example, let’s say you want to make a gift contribution to your grandchild’s traditional IRA, and your grandchild already contributed $3,000 to their IRA this year. This means you would only be able to contribute up to $3,000 to their account so as not to exceed 2021’s yearly contribution limit of $6,000.
Just like with your own IRA, you also need to make sure that your contribution does not exceed the giftee’s total annual income. If your grandchild’s total income for 2021 was $5,000, their IRA contribution limit would also be $5,000 as opposed to $6,000.
All in all, if you plan on making a gift contribution to someone else’s retirement account, it’s best to coordinate with them beforehand to ensure you aren’t exceeding any contribution limits.
Maximize your IRA contributions before 2022
We know saving for retirement isn’t the most glamorous way to spend your money over the holidays. But if you have some extra cash left over this year and you aren’t sure how to put it to good use, saving for your future is always a smart investment. Trust us — future you will be happy you did so!