Content of the material
- How much should I contribute to an IRA?
- Turn your contributions into wealth
- Bottom Line
- Grain of Salt
- Best overall
- Charles Schwab
- Minimum deposit and balance
- Investment vehicles
- IRA recordkeeping
- Dollar-Cost Averaging for IRAs
- Can You Have an IRA and a 401(k) Account?
- Required Minimum Distributions
- Know the contribution limits
- Common questions
- Roth IRA vs. Traditional IRA
- Small Business
How much should I contribute to an IRA?
Know yourself. What kind of life do you want to live in retirement? Some people want to travel, some plan to golf daily while others plan to downsize and live closer to the grandkids. These decisions will impact how much you will need to save to support your lifestyle. A simple, back-of-napkin way to estimate your financial need in retirement is the “Multiply by 25 Rule.” Start with an annual income you’ll be comfortable with in retirement, say, $60,000, and multiply it by 25. That comes out to $1.5 million you’ll need to save to support your desired annual income for 25 years (the average length of retirement in the U.S. is 18 years, according to the U.S. Census Bureau).
Now, this is hardly an exact figure and you probably wouldn’t build a financial plan around it alone. The rule doesn’t factor in tax law changes, inflation, market performance or the fact that retirement can last longer than 25 years. However, it does provide a ballpark figure to see if you’re at least on the right track.
Know your limits. The maximum amount you can contribute to a traditional IRA or Roth IRA (or combination of both) in 2022 is capped at $6,000 — the same as 2021. Viewed another way, that’s $500 a month you can contribute throughout the year. If you’re age 50 or over, the IRS allows you to contribute up to $7,000 annually (about $584 a month).
If you can afford to contribute $500 a month without neglecting bills or yourself, go for it! Otherwise, you can set yourself up for success if you can set aside about 20 percent of your income for long-term saving and investment goals like retirement.
Prioritize high-interest debt, but don’t ignore other goals. Indeed, an IRA is an excellent way to save for retirement, but if you have a lot of high-interest credit card debt you’ll want to expedite paying that. Federal Reserve data show credit card interest rates on balances hover around 14 to 19 percent, while long-term, the stock market has generated average annual returns of roughly 10 percent (7 to 8 percent accounting for inflation), according to the U.S. Securities and Exchange Commission. Clearly, there’s a pretty good chance interest costs will outpace your potential for gains.
Now, prioritizing high-interest debt doesn’t mean neglecting your retirement savings, paying student loans, building your emergency fund or saving for a big trip. However, you want that bad debt off the books as soon as you can manage (without impacting other goals) so your growth isn’t hampered by those pesky interest costs. Maybe instead of contributing $500 a month to an IRA, you bring it down to $250 while using the difference to accelerate payments on debt. With the right plan, you can balance current priorities while setting yourself up well for the future.
Turn your contributions into wealth
Every penny you contribute to your Roth IRA can get you one step closer to building wealth in your account. You may not become a millionaire overnight, but time and patience can help you supersize your returns.
When thinking about how much you should contribute to your Roth IRA, keep your future self in mind. Put yourself in a position to contribute as much as you can now so that you can live life on your terms during retirement.
In 2022, the maximum amount you can contribute to a Roth IRA is $6,000. Since you derive the most benefit from tax-free growth by allowing your funds to earn interest over time, contributing $500 monthly to your Roth IRA instead of once a year means you can earn an estimated $40,000 extra over your lifetime.
Saving for retirement can be complicated, however, and deciding which retirement plans and accounts work best depends on your situation. It may help to speak with an advisor who can help you determine how much you’ll need as well as how to distribute your savings for your specific circumstances. Always make sure you research and understand the benefits from each type of retirement account in order to maximize your savings.
Grain of Salt
Not everyone can spare the money needed to fully max out two or more retirement accounts, so you might not achieve all the steps of this plan. If that’s the case for you, you’ll still want to follow the order of the priorities laid out in the rule, but you might not be able to max out your 401(k) in Step 3 above, for instance.
Another thing to keep in mind is that Roth IRA contribution limits are lower for high earners. For 2022, single filers and heads of households can make the full contribution if their modified adjusted gross income (MAGI) is below $129,000 (up from $125,000 in 2021). Between $129,000 and below $144,000 (up from $125,000 to $140,000 in 2021), a reduced contribution is allowed. If your MAGI is equal to or above $144,000 (up from $140,000 in 2021), you cannot contribute to a Roth IRA. Although there are limitations based on the level of income when contributing to a Roth IRA, an individual can still contribute to a Roth 401(k) if the option is available in the 401(k) offered. The level of income would not be a barrier to saving in an after-tax account.
If your filing status is married-filing-jointly in 2022, you can make the full contribution for MAGI below $204,000 (up from $198,000 in 2021). Between $204,000 and below $214,000 (up from $198,000 to $208,000 in 2021), a reduced contribution is allowed. If MAGI is equal to or above $214,000 (up from $208,000 in 2021), you cannot contribute to a Roth IRA.
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If you have contributed to a nondeductible traditional IRA, you must keep track of your basis. By doing so, you can make sure you won’t pay tax on the money again when you withdraw it.
Basis is usually the combination of these:
- Total amount of nondeductible IRA contributions you’ve made
- Basis from after-tax amounts in qualified retirement plans you’ve rolled over to your traditional IRA accounts
You must file Form 8606 for any tax year you made a nondeductible IRA contribution. You can also use Form 8606 to help you track your total IRA basis. You might have a traditional IRA with basis from nondeductible contributions or rollovers. If so, you’ll need to calculate the taxable portion of any withdrawals.
You might receive both taxable and nontaxable distributions. If so, use Publication 590-B worksheets to help you figure the taxable portion of your IRA withdrawals. You’ll report the taxable and nontaxable portions of the distributions on Form 8606.
Dollar-Cost Averaging for IRAs
Dollar-cost averaging (or systematic investing) is the process of spreading out your investment over a specific time period (a year, for our purposes). It’s a disciplined approach that’s tailor-made for IRA contributions.
With dollar-cost averaging, you invest a certain amount of money into your IRA on a regular schedule. The key thing is you invest that money, generally into either a mutual fund or a stock, regardless of what the investment’s share price is. Some months, you’ll end up buying fewer shares per dollar investment when the share price rises.
But in other months, you’ll get more shares for the same amount of money when prices fall. This tends to level out the cost of your investments. You end up investing in assets at their average price over the year—hence, the term dollar-cost averaging.
Spreading out when you invest is a good idea, especially if you’re risk-averse. It effectively reduces the average cost basis of your investment—and hence, your breakeven point, an approach known as averaging down.
Here’s an example. Let’s say you have $500 to invest in a mutual fund every month. In the first month, the price is $50 per share, so you end up with 10 shares. The next month, the fund’s price falls to $25 per share, so your $500 buys 20 shares. After two months, you would have bought 30 shares at an average cost of $33.33.
Using dollar-cost averaging, you only need to commit $500 per month in order to reach the annual limit, or $250 every two weeks, if you invest on a paycheck-to-paycheck basis.
Can You Have an IRA and a 401(k) Account?
If you or your spouse participates in a retirement plan at work, you can still open and contribute to an IRA up to the $6,000 maximum (or $7,000 for those age 50 or older). However, depending on your modified adjusted gross income (MAGI), you may not be able to deduct the full amount of your contribution. For married couples filing jointly, wherein the spouse making the IRA contribution is covered by a workplace retirement plan, the phase-out range for 2021 is $105,000 to $125,000 ($109,000 to $129,000 for 2022). For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction phases out if the couple's income in 2021 is between $198,000 and $208,000 ($204,000 to $214,000).
Required Minimum Distributions
Certain retirement accounts require that you start taking required minimum distributions from your account starting at age 72. This rule doesn’t apply to Roth IRAs, meaning there’s no requirement that you withdraw money at all. For that reason, a Roth IRA may be used to pay for your later retirement years or as a way to pass on money to the next generation.
Know the contribution limits
The IRS (International Revenue Service) sets contribution limits that cap how much you can sock away in a Roth IRA every year. These limits may make it more difficult to achieve your goal, but that doesn’t mean your $1 million Roth IRA target is impossible.
For 2022, you can contribute up to $6,000 to your account if you’re 49 and under. Once you hit age 50, the IRS will allow you to contribute an extra $1,000 to your Roth IRA. This is known as a catch-up contribution.
Next, we’ll calculate how your contributions can get you to the million-dollar mark.
- When can I access my account?
We’ll send you your account number as soon as your application is completed and approved. You can use your account number to log in and manage your account.
- What are the tax benefits?
With this account, your contributions aren’t tax-deductible – but your earnings grow tax-free and withdrawals can be made tax-free after five years, provided you are age 59½.
You may be eligible for tax-free withdrawals before age 59½:
- In case of death or disability.
- To pay up to $10,000 towards the purchase of a first home.
- To pay up to $5,000 towards birth or adoption expenses.
While there are no current-year tax benefits, you can contribute to a Roth IRA whatever your age, and you won’t need to take Required Minimum Distributions based on your age.
- What are the benefits of a Schwab Roth IRA?
When you open a Roth IRA with Schwab, you get:
- Investment help and guidance.
- Retirement planning tools and resources.
- 24/7 service and support.
- What kinds of investment choices do I have?
Choose from stocks, bonds, ETFs, mutual funds, CDs, and more. Schwab also offers professional portfolio management solutions that can make investing even easier. As a Schwab client, you can speak with a Schwab investment professional who can help you decide which investments are right for you. Just give us a call at 866-855-5635. We’re here and happy to help.
- How much can I contribute each year?
You can contribute $6,000 for the tax year 2021 and $6,000 for the tax year 2022 ($7,000 for tax year 2021 and $7,000 for year 2022 if you are at least age 50) or up to 100% of earned income, whichever is less. Income limits apply.
- What are the eligibility requirements to open a Roth IRA?
There are income limitations to open a Roth IRA account. If you file as a single person and your Modified Adjusted Gross income (MAGI) is above $140,000 for tax year 2021 and $144,000 for tax year 2022 or if you file jointly and you have a combined MAGI above $208,000 for tax year 2021 and $214,000 for tax year 2022, you may not be eligible to start a Roth IRA. See the Roth IRA contribution limits for more information.
- Roth or Traditional IRA—what’s the difference?
A key consideration is whether it makes more financial sense to take advantage of immediate tax benefits or enjoy tax-free withdrawals in retirement. With a Traditional IRA, you may get immediate tax benefits, but you’ll have to pay ordinary income tax on your contributions and earnings when you take money out in retirement. With a Roth IRA, there are no immediate tax benefits, but contributions and earnings grow tax-free. All withdrawals can be taken out tax-free and penalty-free providing you’re 59½ or older and you have met the minimum account holding period (currently five years).
Roth IRA vs. Traditional IRA
The Roth IRA has become one of the most popular investment vehicles for retirement savings thanks to its flexibility. Another tool available is the traditional IRA. Like a Roth IRA, a traditional IRA is an individual account rather than an employer-sponsored one.
When you contribute to a traditional IRA, you’re able to deduct your contributions, which reduces your taxable income in the year you make the contribution. The money in the account grows tax-deferred, and you’ll pay income taxes on the distributions you take during retirement.
“Ultimately, the question of opening a Roth IRA centers around a pivotal question – do I think my income tax rate in retirement will be lower or higher than it is right now?” says Eric Thompson, a Certified Financial Planner and wealth advisor at Round Table Wealth Management.
In general, a Roth IRA is more suitable if you expect your tax rate to be higher during retirement since that’s when it allows you to enjoy the tax savings. A traditional IRA might be the right choice if you expect your retiree tax rate to be lower.
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