Step 4: Contribute up to $5,500 to an Individual Retirement Account (IRA)

After knocking out various debts, setting up a small emergency fund, and contributing to your 401(k), it is time to embrace some major after-tax investments. Step 4 in our ongoing retirement guide is an exciting one: Set up an Individual Retirement Account.

Far more commonly known as an IRA, this is probably the most flexible way to save thousands on taxes while also maintaining the type of liquidity you can’t find with a 401(k) or by paying down your mortgage. Both the tax savings and the flexibility are maintained whether you choose to open a Traditional or a Roth account — or both.

Definition

An Independent Retirement Account, or IRA, is an opportunity to place money into tax-advantaged beyond your employer-sponsored 401(k). If you work at a company that doesn’t offer a 401(k), this is your only opportunity to invest and save on taxes.

After all, only 14% of American employers even offer a 401(k) in the first place.

  • Roth IRA:
    • An “Independent Retirement Account” is exactly that — independent. Anyone can (and in the humble opinion of yours truly, should) invest up to $5,500 annually into a Roth IRA using “post-tax” money.
    • There is a $1,000 “catch-up” contribution allowance for those over the age of 50 for a total of $6,500 allowed instead of the $5,500 for those under the age of 50.
    • There is no Required Minimum Distribution. If you wind up never needing to touch this money in retirement, you can let it grow indefinitely and leave it to your surviving family and friends, unlike with a 401k where you must begin removing funds at the age of 70.5.
    • There is NO PENALTY if you remove the PRINCIPAL of the account at any time. In other words, the money you put in can be taken out at any time, but there IS A PENALTY if you remove the growth/dividends before turning 59.5 years old.
  • Traditional IRA:
    • Like a Roth IRA, anyone can invest in this tax-advantaged savings vehicle.
    • Unlike a Roth but similar to a Traditional 401k, the money goes into the investment pre-tax, but you do pay taxes on the money when you make withdrawals in retirement.

I’m not great at math, but 14% is not a high number.

Embrace the tax-savings, low fees, and flexibility of an IRA and get rich

If you work at one of the 86% of Stateside companies that don’t offer a 401(k), you will have to invest in an IRA to enjoy tax-free compound interest.

If you work at a company that does offer a 401(k), you will want to start investing in an IRA once you have reached the company match. For example, if you are making $100,000 a year and your company matches 100% of 4% of your salary, you will be setting aside $4,000 of your own cash while your company matches with another $4,000. That is $8,000 total.

You have $14,000 to go before your reach the annual $18,000 savings threshold for those under the age of 50 (Employer contributions do not count towards the limit). However, before upping your contribution, invest $5,500 of that money into an IRA instead.

Why?

  • More than likely the investment choices offered in an IRA will have lower fees than those offered by your 401(k).
  • You can take out up to $10,000 from your IRA for a first-time home purchase.
  • As mentioned previously, you can remove any and all of your principal penalty-free at any time.

Too easy.

At this point, out of your $100,000 salary, you’ve put $8,000 into a 401(k) and $5,500 into an IRA. That is $13,500 you have put towards retirement. That 13.5% is more than the average American savings rate of 5.7% — without worrying about paying any taxes on the gains and dividends accrued over hopefully several decades.

If your salary stands at $50,000 you can still save the same amount of money.

In fact, if it were up to yours truly over here at Nest Egg Ninjas, everyone would be saving at least 20% towards retirement.

It all starts with one thing: Getting motivated to save for the long-term.

What’s the catch?

Well, if you are one of the very few Americans making more than $117,000 this year, there’s a fairly major one: Your contribution limits are reduced, and phased out entirely after crossing the $132,000 annual income threshold.

If you are married filing jointly, those numbers stand at $184,000 and $194,000.

What does this mean?

  • If you are a single individual filing your taxes and your income comes in at $116,999 or less, you can contribute up to the maximum of $5,500 (plus an extra $1,000 for those who meet the age requirement noted above) into your Traditional or Roth IRA.
  • If you make more than $132,000, you cannot contribute to a Roth IRA at all.
    • You can still contribute to a Traditional IRA using pre-taxed earnings that will be taxed upon withdrawal.
  • If you are married and filing jointly with combined incomes under $183,999, you can contribute the maximum of $5,500 per person (again, plus more for those trying to catch up on their retirement contributions).
  • You cannot contribute at all after you cross the $194,000 threshold.
  • In between, you can contribute a little, but not the maximum amount

Thanks very much to The Rich Miser and JB for helping me along!

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Check out the ongoing, full retirement ladder here:

Step 0: Create a budget that helps you get wealthy

Step 1: Why building an emergency fund is so important for your nest egg

Step 1.5: What type of account is best for your emergency fund?

Step 2: Contribute to your 401(k) up to the company match

Step 2.5: How should I pick the best 401(k) investments for me?

Step 3: Pay off all high-interest debt as aggressively as possible

5 Comments

  1. JB said:

    The first time I commented it failed so here is the condensed version. My understanding is the employer match does not count towards the 18k limit. Therefore the employee could contribute an additional 14k after the first 4K.

    September 13, 2017
    Reply
    • NestEggNinja said:

      Hi JB!

      Sorry the website has been extremely finicky all week, unfortunately. You are correct, however, and the post has been edited accordingly. Sincerely, THANK YOU and please don’t hesitate to reach out any time to make sure I am providing my readers with the most accurate information possible.

      September 15, 2017
      Reply
  2. JB said:

    You mentioned that a person would have $10,000 left to contribute to a 401k after $4k contribution and $4k company match. The person could actually contribute $14k as the company match does not count towards the contribution limit.

    September 12, 2017
    Reply
  3. I think IRAs are great ideas. The only caveat is that there are tax deductibility limits for high earners. If you make too much, traditional IRA contributions cease to be tax-deductible.

    August 30, 2017
    Reply
    • NestEggNinja said:

      Excellent point and absolutely something I should have included in this post! I am going to clean this up to provide a more thorough explanation of who can and cannot take advantage of a Roth account. Thanks!!

      August 30, 2017
      Reply

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