Everywhere one goes in the financial arena, the resounding chorus is that people should save more for retirement while they can. While saving is a good thing, the federal government has put a cap on exactly how much can be saved annually.
Every year the Internal Revenue Service updates and notifies the general public of how much can actually be deposited in an individual retirement account by an individual. Otherwise known as IRAs, these accounts provide legal tax shelters for funds dedicated to retirement versus generic savings. The nature of the tax shelter depends on the nature of the money deposited. All earned income is subject to payroll taxes. If the money is pre-tax, then placement in an IRA defers the payroll taxes until a later date. If the money is post-tax, it represents funds after payroll taxes have been taken out. Whether it be a traditional IRA which is for pre-tax money, or in a Roth IRA which is for post-tax monies, the most a person can deposit in 2013 and 2014, respectively, is $5,500. However, if a person is 50 years or older, a catchup provision allows a higher individual amount of $6,500. An exception to both is if a person has earned less than these figures in a year. Then the deposit limit is capped at the lower amount.
It’s important to note spousal IRAs can help make up for a partner not working an unable to deposit. In this case one partner earns all the income, but can deposit to both her own IRA as well as a separate IRA for the non-working spouse.
Some people cannot deposit into an IRA at all. Both types of retirement accounts have restrictions for higher-income earning people, essentially phasing out their ability to deposit in a calendar year the more money that is earned above the threshold. That phase-out period begins at $112,000/year and turns into a complete restriction from depositing at $127,000/year in 2013. Married couples have a more room to work with starting at $178,000/year and ending at $188,000/year.
Further, with a traditional IRA, a depositor can no longer add more money to the balance after age 70 ½ years. Instead, the IRS requires such individuals to begin taking money out of the account, which is known as a minimum required withdrawal. This is how the IRS ensures the pre-tax funds are eventually charged for income tax. After that, the net amount can be deposited anywhere, including a Roth IRA. Rollover contributions are not affected by this situation, however.
The above deposit limits do not apply to rollover contributions. This occurs when a person takes monies in one type of retirement account and transfers it to another. That said, unless the accounts are the same type, payroll taxes could apply on the transfer amount. This is why it’s smart to rollover to a similar account, i.e. a pre-tax 401K balance rolled over to a pre-tax traditional IRA.
The other exception to the above limits involved qualified reservist repayments. These funds can also be deposited without worrying about an IRA cap.
Where deposits exceed maximum contributions, the IRS will receive a report from the IRA administrator entity, which then triggers penalties. Far more detail on related penalties as well as maximum limits can be found in IRS Publication 590, including how withdrawal taxes apply or not.