The IRA is a pre-tax retirement vehicle available to most people who work for an employer and make less than $69,000 a year. If your modified adjusted gross income is $59,000 or less and you do have a retirement plan offered at work, you can take the full deduction of currently $5,500. If you are married, you get to contribute the full pre-tax IRA contribution if your AGI is under $95,000. Deductions are gradually phased out once you reach incomes of $69,000 for individuals and $115,000 for married couples.
If you do not have a retirement plan offered at work (rarer case), the rules are a little different. There is no income limit for individuals, and a full deduction of up to $178,000 in joint income, partial deduction from $178,000-$188,000, and no deduction if joint income is above $188,000. The best thing you can do is ask your benefits department to see if you qualify because the laws are changing all the time.
From 1974 until 1980, the IRA contribution limit for investors was $1500. From 1981 until 2001 the contribution limit improved to $2000. In 2002 the limit was raised to $3,000, again to $4000 in 2005, one more time to $5,000 in 2008 and now to $5,500 in 2013. I don’t know about you, but such low limits are hardly anything to get excited about.
When I graduated from college in 1999, my base income was $40,000 living in NYC. I was considering contributing to an IRA until I learned more about the contribution restrictions. Adding $2,000 to my IRA at the time felt stupid when I was busy trying to max out my 401(k) which had a more reasonable contribution limit of $10,000. Besides, I didn’t want to not be able to contribute pre-tax money to an IRA the very next year just in case I made more than their arbitrarily low income limit.
You’ll discover in this article that even small contributions add up over time. So don’t be stupid like me and not contribute while you still have the opportunity. Make deferring taxes a key tenet in your efforts to achieve financial independence. Taxes are our biggest expense and you want to save more than the government taketh away!
THE CURRENT AVERAGE EXISTING IRA BALANCE
According to Fidelity, one of the largest administrators of retirement plans in America with ~ 7 million accounts, the average IRA balance — including both traditional IRAs and Roth IRAs — stood at $81,100 at the end of 2012, up 53% from 2008 when balances hit their lowest point since the market meltdown. We can comfortably assume the balances are even higher in 2013 thanks to a 15%+ rise in the markets to date.
The $81,100 figure is somewhat meaningless if we don’t take age into consideration. If you only have $81,100 in your IRA as a 60 year old, you better have a hefty 401(k) portfolio to aide in your impending retirement. If you’ve got $81,100 in your IRA as a 30 year old, then you’re doing fine considering the contribution limits. We should understand that the average American age is in the mid-30s, which provides better context to the $81,100 figure.
This post will attempt to address what people SHOULD have in their IRA if they want to have a shot at a financially sound retirement by the traditional age of 60. Before we look at the chart, let’s make some assumptions.
The assumptions for the below chart are as follows:
* You realize the only person most capable of taking care of your financial future is yourself. You do not depend on the government, a boyfriend, a girlfriend, a spouse, or parents to fund your retirement.
* You make less than $69,000 as an individual and $115,000 as a married person with an employer sponsored retirement plan or make less than $178,000 as a married couple with no employer retirement plan.
* You begin maxing out your IRA after your first full year of work. Most high school, associates degree, or college graduates find jobs during the summer. The six month window between summer and the new year is often a time of discovery and confusion. It takes a while to figure out one’s steady state budget before making retirement decisions unless you’ve been an avid reader of personal finance publications well before work.
* You realize the IRA is a woefully light pre-tax retirement vehicle that must be accompanied by 401(k) savings or after tax savings. As a result, there are no excuses to not max out your IRA contributions by the time you’ve had three years of experience under your belt, or by the time you turn 25.
* Your IRA portfolio returns anywhere between 3% up to 15% depending on the year with an average of around 6%. Better to be conservative and end up with too much, than too little.
* Upward and downward adjusts are made to account for bull markets and market meltdowns.
* Contribution limits are raised by $500 every five years.
* You focus on maxing out your IRA instead of a ROTH IRA because you are against giving more money to the government given how wasteful they are, and you realize your income in retirement will be less than your income while working.
* You are not a knucklehead who consistently spends more than s/he makes. Just by searching this topic, you are taking ownership of your retirement and are thinking ahead with an action plan.
IRA BALANCES BY AGE GUIDE FOR THOSE STARTING NOW
The above chart is forward looking based on existing IRA contribution amounts. For those entering the work force today, in 38 years you will conservatively have anywhere between $350,000 to $1,062,500 depend on market conditions.
IRA BALANCE BY AGE BASED ON PAST LIMITS
The above chart takes into consideration historical lower level IRA contribution limits starting from 1981 until the year 2019. 1981 is chosen because that was the beginning of the IRA program. The chart rewinds back in time what if you started working the day the system began up until age 60.
Readers are free to select the chart that is most appropriate for them, or even select an amount based on age from each chart and average the two to get a hybrid figure. Finally, the chart is for individuals, so feel free to double them up if you qualify and are married.
CONCLUSION – SAVINGS ADDS UP!
We should be pleasantly surprised to see how much contributing even $2,000 a year in savings adds up over time. Compounding is a wonderful thing and the key is to get to that magical inflection point where the returns from your portfolio start making more than your contributions. With a current maximum IRA contribution limit of $5,500, a $100,000 IRA portfolio returning just 6% will start overtaking your contributions. Each year will be like a 2-for-1 special to get the snowball growing. Build your financial nut so your money really starts working for you!
The current average IRA balance of $81,100 is the anchor by which my calculations are based for both charts . The key is to keep on saving so long as your paycheck comes in instead of use every excuse under the sun to stop. You can read my recommendation for the proper asset allocation between stocks and bonds by age. It’s important to be diversified and more conservative the closer you get to retirement. I’ve taken into consideration lower returns post 50 in the first chart due to lower risk portfolio investments.
Due to income limitations for contribution, it will be difficult to continuously max out your IRA of $5,500 along with $17,500 for a 401k based on a $59,000 single salary, or $95,000 married combined salary if you have an employer sponsored retirement plan. That said, it can be done if you really want to be disciplined. Please take a look at the average 401(k) by age chart to see what type of financial power you can really amass if you stay the course. Whatever you do, at least max out one throughout the entire course of your career.
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Note: As asked in the comments section, for those who are looking for a good traditional IRA provider because your employer doesn’t have a sponsored retirement program, I’ve been using E*TRADE for over 10 years. They are cheap, have no minimums, easy to use, and have a huge selection of investment options.
Photo: Our villa in Mallorca, 2013.