How Do Contribution Limits Impact My Retirement Savings?

Many people aren’t fortunate enough to work for an employer who offers a pension plan, and a large majority of the workforce doesn’t feel confident that social security will be around when they retire. Although, both were previously the basis of many people’s retirement plan, now a growing amount of the population is turning towards creating their own retirement savings through 401(k) plans and IRAs. However, the contribution limits for these types of accounts puts a limit on how much people can save for their retirement.


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Traditional and Roth IRAs

As of this writing in 2012, the contribution limit for these types of IRAs is $5,000 per year for individual accounts. People over 50 can contribute an additional $1,000 per year, often called a catch-up contribution, which allows them to contribute $6,000 per year total. The contribution limit for IRAs is indexed to inflation so it may go up in future years.

401(k) Plans

401(k) plans contribution limits are more complicated than IRAs and vary by plan. Employees contribute a percentage of their salary based on what their plan allows. Typically employers match the employee’s contribution by the same percentage of pre-tax income, however the employer’s contribution does not count towards the yearly limit. Currently, the maximum annual contribution limit is $17,000 for people under 50. Some plans will allow an employee to contribute more, but the amount over $17,000 is not made from pre-tax dollars, which means you pay taxes on that money when you earn it and again when you withdraw your 401(k). Many, but not all, plans allow employees over 50 to contribute an additional $5,500 per year as a catch up contribution.

Simple IRA

Simple IRA accounts are intended for small businesses with fewer than 100 employees. In most cases employers are required to make a contribution, but the amount varies according to the plan and may not always be dollar for dollar. In 2012, the contribution limit is $11,500 per year with a catch up contribution of $2,500 for employees over 50.

SEP-IRA

SEP-IRA accounts are intended for a person who owns a business, independent contractors and anyone who is self-employed. Contributions can go as high as 25% of a person’s gross annual salary or 20% of their net adjusted self-employment income. However, there is still a maximum contribution limit of $50,000 per year. There are no provisions for catch up contributions.

Contribution limits are important to keep in mind, because it confines how much you can save via your IRA or 401(k). For example, say a worker starts contributing to his or her Traditional or Roth IRA at age 35 and wants to retire at 55. That worker would only have an IRA savings of $105,000. That may seem like a lot of money, but it’s a pittance if you’re planning to live another 20+ years after retiring. Combine your retirement account with your stock market investing strategy and you’ll ultimately end up with a stronger package to retire with in the end.

About the Author: Natisha Waligora is working hard to create both a retirement and investment portfolio that will see her will into her golden years. She’s currently working with valuestockguide.com/premium to explore her options and is considering going to school to better understand investment strategies.

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