New Rules for Contributing to IRAs and 401(k)s

Contributing money to an Individual Retirement Account (IRA) and your workplace’s retirement savings plan can help you reach your retirement goals. To take full advantage of these savings opportunities, you need to stay current with changes to contribution limits and the tax deductibility of IRAs.

The maximum amount you can contribute to a Traditional IRA or Roth IRA in 2012 remains unchanged from 2011 at $5,000. You should note that you can contribute to both a Traditional and Roth IRA, but your total contributions for 2012 cannot exceed this $5,000 limit. However, there is a special $1,000 catch-up contribution for investors who are age 50 or older that also remains unchanged for 2012. Therefore, if you are age 50 or over, you can contribute $6,000 to an IRA in 2012.

While contribution limits remain the same, there is a notable change on income limits for opening a Roth IRA. For 2012, income limits for making contributions to a Roth IRA increased to between $110,000 and $125,000 for singles and heads of household for 2012, up $3,000 from 2011. For married couples filing jointly the income limits to qualify to open a Roth have increased by $4,000 to a phase out range of $173,000 to $183,000. Remember, however, that while your income may prevent you from opening a Roth IRA, anyone, regardless of income, can convert a Traditional IRA to a Roth IRA.

Keep in mind that you can make your 2012 IRA contribution as early as January 2 for the whole year. However, because annual IRA contributions can be made from January 2 of the current year through April 15th of the following year, be sure to specify your intended calendar year. That is, a contribution you make from January 2, 2012 through April 15, 2012 could be applied either to 2011 or 2012.

Making an IRA contribution every year can add up, particularly if you begin saving at a young age. For example, if you save $5,000 each year starting at age 25, assuming an annual rate of return of 7 percent, you would have a $1,528,759 nest egg by the time you are 70 years old. If you begin saving $5,000 each year when you are 35 and, assuming the same rate of return, you would have $739,567 at age 70—an impressive amount, but less than half of what you would have if you started saving a decade earlier. And if you wait until age 40 to begin your annual $5,000 IRA investment and you would have $505,365 at age 70, assuming an annual rate of return of 7 percent.

While the maximum IRA contribution limits have not changed, the income limits for determining the deductibility of Traditional IRA contributions have increased. For example, you can fully deduct your IRA contribution if your filing status is single/head of household, and your modified adjusted gross income (MAGI) is $58,000 or less (up from $56,000 in 2011). If you’re married filing a joint return, you can fully deduct your IRA contribution if your MAGI is $92,000 or less (up from $90,000 in 2011). If you’re not covered by an employer plan but your spouse is, and you file a joint return, you can fully deduct your IRA contribution if your MAGI is $173,000 or less (up from $169,000 in 2011). If your joint income is between $173,000 and $183,000, you qualify for a partial IRA deduction.

While IRA contribution limits have not changed this year, the maximum amount you can contribute to your 401(k) plan has increased for 2012. The 2012 401(k) limit—which also applies to 403(b), 457(b), and SAR-SEP plans—is $17,000, up $500 from $16,500 in 2011. If you’re age 50 or older, you also can make catch-up contributions of up to $5,500 to these plans in 2012, unchanged from 2011. (Special catch-up limits apply to certain participants in 403(b) and 457(b) plans.)

If you participate in more than one retirement plan, your total elective deferrals cannot exceed the annual limit ($17,000 in 2012 plus any applicable catch-up contribution). Deferrals to 401(k) plans, 403(b) plans, SIMPLE plans, and SAR-SEPs are included in this limit, but deferrals to Section 457(b) plans are not. For example, if you participate in both a 403(b) plan and a 457(b) plan, you can defer the full dollar limit to each plan—a total of $34,000 in 2012 (plus any catch-up contributions).

The amount you can contribute to a SIMPLE IRA or SIMPLE 401(k) plan in 2012 remains at $11,500 ($14,000 if you’re age 50 or older), unchanged from 2011.

You should contact your financial advisor if you need help sorting out the benefits of saving in an IRA versus investing in your 401(k), evaluating whether a Traditional IRA or a Roth IRA would be the most effective retirement savings vehicle, or determining whether you should convert your Traditional IRA to a Roth IRA. You should also consider discussing Rollover IRAs. Specifically, if you have 401(k) accounts from old jobs, a Rollover IRA can offer you a wider universe of investment choices, easier record keeping, and greater flexibility in the estate planning department.

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