Why You Should Increase Your IRA Contribution

May 18, 2012

By Staff writer State Farm™ Employee

One way to have a larger retirement fund is to save more now. There are two limits on this. The first, of course, is how much money you are able to save. Some people have greater resources than others, but you may be able to find ways to save money by cutting back spending on unnecessary items.

The second limit is the amount of your retirement savings contribution that is deductible from your income taxes. The greater the deduction, the more value you get from your savings.

When the Individual Retirement Arrangement, also known as a traditional IRA, was set up by law in 1975, the maximum amount that investors could deduct was $1,500. It was raised to $2,000 in 1981, and that limit stayed in place for 20 years. It was raised by Congress in 2002, 2005, and in 2008. The 2008 contribution limit was $5,000. More importantly, the law allowed for automatic increases in the IRA contribution limit, without the need to pass additional legislation, to correspond to cost of living increases.

Because inflation has been very low in recent years, the 2012 contribution limit remains at $5,000. But that’s only if you are under age 50. If you’ve turned 50 since you last evaluated your IRA contributions, you may be in for a pleasant surprise. After you turn 50, you can contribute and deduct an additional $1,000 per year, known under the law as a “catch-up” contribution.

The difference is significant. If you put $2,000 away for 30 years, then your total contribution would be $60,000 – and that’s before earning any investment returns. Put away $5,000 for 15 years and $6,000 for another 15 years, and your total contribution would be $165,000.

Assuming you earn an average annual investment return of 5 percent, the total value of your account may grow far beyond the amount that you have contributed. At that rate, a $2,000 annual contribution will compound to a $139,522 nest egg after 30 years. If you begin saving at age 35, make the $5,000 contribution until age 50, then contribute the full $6,000 starting at age 51, then your nest egg would be $371,461.

Years Before Retirement At Age 65 $2000 Annual Contribution $5000 Annual Contribution $5000 Contribution, $6000 After Age 50
10 Years $26,414 $66,034 $79,241
20 Years $69,439 $173,596 $196,254
30 Years $139,522 $348,804 $371,461

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These numbers assume that contribution limits will remain where they are now, but they are expected to increase in future years with increases in the cost of living. Before you make your annual IRA contribution, check with your financial advisor or the IRS to determine your contribution limit.

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