IRA Contribution Limits: How Much Can You Save?

Quick answer

• The IRS sets annual limits on how much you can contribute to an IRA.
• For 2023, the limit is \$6,500, or \$7,500 if you’re age 50 or older.
• These limits apply to the total of all your IRAs, not per account.
• Contribution limits can change annually due to inflation adjustments.
• If you exceed the limit, you may face penalties.

What to check first (before you invest)

Time Horizon

Your investment timeline is crucial. Are you saving for retirement decades away, or a shorter-term goal like a down payment in five years? Longer horizons generally allow for more aggressive investment choices, while shorter ones may call for more conservative approaches. Understand how long you have to save and how long your money will be invested.

Risk Tolerance

How comfortable are you with the possibility of losing money in exchange for potentially higher returns? Your risk tolerance influences the types of investments you’ll choose. Younger investors with a long time horizon might tolerate more risk, while those nearing retirement may prefer to reduce it. Be honest with yourself about your comfort level with market fluctuations.

Emergency Fund

Before investing, ensure you have a solid emergency fund. This fund should cover 3-6 months of essential living expenses, held in a readily accessible, low-risk account like a savings account. Investing money you might need suddenly can force you to sell at a loss during a market downturn.

Fees and Tax Impact

Understand the fees associated with any investment you consider, as they can significantly eat into your returns over time. Also, consider the tax implications of different account types and investment choices. Some investments grow tax-deferred or tax-free, which can be a significant advantage.

Account Type (IRA, 401(k), Brokerage)

Determine which account type best suits your savings goals. Traditional IRAs and Roth IRAs offer tax advantages for retirement savings. Employer-sponsored plans like 401(k)s often come with matching contributions, which is essentially free money. A taxable brokerage account offers flexibility but lacks the tax benefits of retirement accounts.

Step-by-step (simple workflow)

1. Determine your eligibility for IRA contributions.

• What to do: Check if you have earned income and if your income falls within the limits for deducting Traditional IRA contributions (if applicable). Roth IRA contributions have income limits as well.
• What “good” looks like: You have confirmed you meet the basic requirements for contributing to an IRA.
• Common mistake: Assuming you can contribute without earned income. You must have income from working to contribute to an IRA.

2. Identify the current year’s IRA contribution limits.

• What to do: Look up the official IRS limits for the current tax year. These are adjusted annually for inflation.
• What “good” looks like: You know the exact maximum dollar amount you can contribute for the year.
• Common mistake: Using outdated contribution limits from previous years. Always verify the most current figures.

3. Assess if you qualify for catch-up contributions.

• What to do: If you are age 50 or older by the end of the tax year, you can contribute an additional amount above the standard limit.
• What “good” looks like: You know the total combined limit including the catch-up contribution if you’re eligible.
• Common mistake: Not taking advantage of catch-up contributions if you are eligible, leaving potential savings on the table.

4. Calculate your total potential IRA savings.

• What to do: Based on the limits and your eligibility for catch-up contributions, determine the maximum you can save across all your IRAs.
• What “good” looks like: You have a clear figure for your maximum annual IRA contribution.
• Common mistake: Contributing to multiple IRAs without tracking the combined total, potentially exceeding the overall limit.

5. Review your current financial situation.

• What to do: Assess your budget, emergency fund status, and any other financial priorities.
• What “good” looks like: You are confident that contributing the maximum amount will not jeopardize your immediate financial stability.
• Common mistake: Over-contributing to an IRA at the expense of essential expenses or failing to maintain an adequate emergency fund.

6. Choose your IRA type(s).

• What to do: Decide between a Traditional IRA (potential tax deduction now) or a Roth IRA (tax-free withdrawals in retirement). You can have both, but the contribution limits apply to the combined total.
• What “good” looks like: You have selected the IRA type(s) that align with your current and future tax expectations.
• Common mistake: Not understanding the tax differences between Traditional and Roth IRAs, leading to a less optimal choice for your situation.

7. Open or fund your IRA(s).

• What to do: If you don’t have an IRA, open one with a financial institution. If you already have one, make your contribution for the year.
• What “good” looks like: Your chosen IRA account is open and funded with your intended contribution.
• Common mistake: Waiting until the last minute to open or fund an IRA, missing deadlines or making rushed decisions.

8. Select your investments within the IRA.

• What to do: Choose investments like mutual funds, ETFs, or individual stocks that align with your risk tolerance and time horizon.
• What “good” looks like: You have invested your contributions in a diversified portfolio suitable for your goals.
• Common mistake: Letting the money sit in cash within the IRA, missing out on potential growth and the benefits of compounding.

9. Track your contributions throughout the year.

• What to do: Keep a record of how much you’ve contributed to ensure you don’t exceed the annual limit.
• What “good” looks like: You have a clear understanding of your contribution progress and are well within the limits.
• Common mistake: Forgetting to track contributions and accidentally over-contributing, which can lead to penalties.

10. Understand the contribution deadline.

• What to do: Remember that you can contribute to an IRA for a given tax year up until the tax filing deadline of the following year (typically April 15th).
• What “good” looks like: You are aware of the deadline and have made your contributions by then.
• Common mistake: Missing the deadline and being unable to contribute for that tax year, or having to rush contributions.

Risk and diversification (plain language)

• Risk is the chance your investment could lose value. For example, a stock in a company might go down in price if the company doesn’t perform well.
• Diversification means spreading your money across different types of investments. Think of it like not putting all your eggs in one basket.
• Different investments have different risks. Stocks are generally considered riskier than bonds, but they also have the potential for higher returns over the long term.
• Examples of diversification: Investing in a mix of stocks, bonds, and real estate. Within stocks, you might invest in companies of different sizes (large, medium, small) and in different industries (technology, healthcare, consumer goods).
• Asset allocation is how you divide your money among these different investment categories. A common strategy is to have more stocks when you’re young and gradually shift to more bonds as you get closer to retirement.
• Mutual funds and Exchange-Traded Funds (ETFs) are popular ways to diversify. They hold a basket of many different securities, offering instant diversification with a single purchase.
• Market drops are a normal part of investing. When the market falls, it can be unsettling, but it’s often a temporary situation.
• What to do during market drops: Avoid making impulsive decisions to sell. For long-term investors, market downturns can be opportunities to buy assets at lower prices. Sticking to your original investment plan is usually the best approach.

Common mistakes (and what happens if you ignore them)

| Mistake | What it causes