Making Contributions to Your Individual Retirement Account

Quick answer

• Decide how much to contribute based on your income, age, and savings goals.
• Choose between a Traditional IRA or a Roth IRA based on your current and expected future tax situation.
• Open an IRA account with a brokerage firm, bank, or other financial institution.
• Set up automatic contributions to ensure consistent saving.
• Understand contribution limits and deadlines set by the IRS.
• Be aware of potential tax implications and withdrawal rules.

What to check first (before you invest)

Time Horizon

Your investment timeline dictates how much risk you can afford to take and what types of investments are suitable. A longer time horizon generally allows for more aggressive investing, as there’s more time to recover from market downturns. For example, someone saving for retirement in 30 years can likely afford to invest more heavily in stocks than someone planning to withdraw funds in five years.

Risk Tolerance

This is your emotional and financial capacity to handle investment losses. Are you comfortable with the possibility of your investments losing value in the short term for the potential of higher long-term gains, or do you prioritize capital preservation? Understanding your risk tolerance helps you choose investments that won’t cause undue stress.

Emergency Fund

Before contributing to an IRA, ensure you have a solid emergency fund. This fund, typically covering 3-6 months of living expenses, acts as a buffer against unexpected costs like job loss or medical emergencies. Tapping into retirement savings for emergencies can incur penalties and taxes, significantly hindering your long-term goals.

Fees and Tax Impact

Be aware of any fees associated with your IRA, such as account maintenance fees, transaction fees, or fund expense ratios. These can eat into your returns over time. Also, consider the tax implications of your IRA type. Traditional IRAs offer pre-tax contributions, while Roth IRAs offer tax-free withdrawals in retirement. Your current and projected future tax bracket is a key factor in this decision.

Account Type (IRA vs. Brokerage)

For retirement savings, an IRA (Traditional or Roth) offers significant tax advantages over a standard taxable brokerage account. IRAs are specifically designed for long-term retirement growth with tax benefits. A brokerage account offers more flexibility but lacks the tax advantages for retirement savings.

How to Put Money in an IRA: A Step-by-Step Guide

1. Determine Your Contribution Amount

What to do: Calculate how much you can realistically afford to contribute each year, considering your income, expenses, and other financial goals. The IRS sets annual contribution limits, which can change.
What “good” looks like: You’ve set a consistent contribution amount that aligns with your budget and maximizes the IRS contribution limit without causing financial strain.
A common mistake and how to avoid it: Overcommitting to a contribution amount you can’t sustain. Avoid this by starting with a smaller, manageable amount and increasing it gradually as your income or expenses change.

2. Choose Between Traditional and Roth IRA

What to do: Evaluate your current income and tax bracket versus your expected income and tax bracket in retirement.
What “good” looks like: You’ve chosen the IRA type that offers the greatest tax advantage for your personal financial situation.
A common mistake and how to avoid it: Not understanding the tax implications. For example, contributing to a Roth IRA when you’re in a high tax bracket now might be less advantageous than a Traditional IRA, where you get a tax deduction today. Consult a tax professional if unsure.

3. Select an IRA Provider

What to do: Research and choose a financial institution (brokerage firm, bank, mutual fund company) to open your IRA with. Consider factors like investment options, fees, customer service, and ease of use.
What “good” looks like: You’ve selected a reputable provider with low fees and a good selection of investments that match your strategy.
A common mistake and how to avoid it: Choosing a provider solely based on marketing without comparing fees or investment choices. Always compare offerings from several providers.

4. Open Your IRA Account

What to do: Complete the application process with your chosen provider. This typically involves providing personal information, selecting your account type (Traditional or Roth), and agreeing to terms.
What “good” looks like: Your IRA account is successfully opened and ready for funding.
A common mistake and how to avoid it: Providing incomplete or inaccurate information, which can delay the account opening. Double-check all details before submitting.

5. Fund Your IRA (One-Time or Recurring)

What to do: Decide whether to make a lump-sum contribution or set up regular, smaller contributions. Most providers allow you to link a bank account for easy transfers.
What “good” looks like: Your IRA is funded, either with a single deposit or with a plan for ongoing contributions.
A common mistake and how to avoid it: Forgetting to actually transfer money into the account after opening it. Set up an automatic transfer immediately after account opening.

6. Set Up Automatic Contributions (Recommended)

What to do: Schedule automatic transfers from your checking or savings account to your IRA on a regular basis (e.g., bi-weekly, monthly).
What “good” looks like: Contributions are happening consistently without you having to remember each time, maximizing your savings potential.
A common mistake and how to avoid it: Relying on manual contributions, which can be easily forgotten or delayed. Automation removes this hurdle.

7. Choose Your Investments

What to do: Once funded, decide how you want to invest the money within your IRA. This could include stocks, bonds, mutual funds, ETFs, or target-date funds.
What “good” looks like: Your investments are aligned with your time horizon, risk tolerance, and financial goals.
A common mistake and how to avoid it: Not investing the money at all, leaving it in cash where it loses purchasing power due to inflation. Even a conservative investment strategy is better than no investment.

8. Monitor Your Account Periodically

What to do: Review your IRA’s performance and your investment allocation at least annually, or when significant life events occur.
What “good” looks like: You understand how your investments are performing and are confident they remain aligned with your goals.
A common mistake and how to avoid it: Setting it and forgetting it without rebalancing or adjusting your strategy as you age or market conditions change. Regular check-ins prevent your portfolio from drifting too far from its intended allocation.

9. Be Mindful of Contribution Deadlines

What to do: Know the IRS deadline for making contributions for a given tax year. This is typically in April of the following year.
What “good” looks like: You’ve made all your intended contributions for the tax year by the deadline.
A common mistake and how to avoid it: Missing the deadline and losing the opportunity to contribute for that tax year. Mark the deadline on your calendar well in advance.

10. Understand Withdrawal Rules

What to do: Familiarize yourself with the rules for withdrawing funds from your IRA, especially before retirement age.
What “good” looks like: You know the potential penalties and taxes associated with early withdrawals and can avoid them.
A common mistake and how to avoid it: Withdrawing funds for non-essential reasons before age 59½ without understanding the penalties and taxes. This can significantly set back your retirement savings.

Risk and Diversification in Your IRA

Diversification is a strategy to reduce risk by spreading your investments across different asset classes, industries, and geographic regions. The idea is that if one investment performs poorly, others may perform well, cushioning the overall impact on your portfolio.

• Don’t Put All Your Eggs in One Basket: This is the core principle of diversification. For example, instead of investing all your IRA money in a single tech stock, you might invest in a broad market index fund that holds stocks from many different companies across various sectors.
• Asset Allocation: This means dividing your investments among different types of assets, such as stocks (for growth potential), bonds (for stability), and cash equivalents (for liquidity). An example allocation might be 70% stocks and 30% bonds for a younger investor.
• Within Stocks: Diversify across different industries (e.g., technology, healthcare, energy) and company sizes (large-cap, mid-cap, small-cap). Owning shares in a tech company and a utility company provides diversification.
• Geographic Diversification: Invest in companies based in different countries. This can protect you if one country’s economy experiences a downturn. For instance, holding both U.S. stocks and international stocks.
• Bonds: Diversify bond holdings by maturity (short-term vs. long-term) and issuer type (government vs. corporate).
• Mutual Funds and ETFs: These are inherently diversified investment vehicles. A single mutual fund can hold hundreds or even thousands of different securities, offering instant diversification.
• Target-Date Funds: These funds automatically adjust their asset allocation to become more conservative as you approach your target retirement date, providing built-in diversification that evolves over time.
• Avoid Overlapping Funds: Be careful not to buy multiple funds that invest in very similar assets, as this can reduce the diversification benefit.

What to do during market drops: During market downturns, it’s crucial to stick to your long-term investment plan. Avoid panic selling, which locks in losses. Instead, view market dips as potential buying opportunities if your investment strategy allows. Rebalancing your portfolio periodically can help maintain your desired risk level.

Common Mistakes (and what happens if you ignore them)

Mistake	What it causes	Fix
Not having an emergency fund first	You may be forced to withdraw from your IRA early, incurring penalties and taxes, which significantly hinders your retirement savings.	Build a robust emergency fund (3-6 months of living expenses) before contributing to an IRA.
Contributing to the wrong IRA type	You miss out on optimal tax advantages based on your current and future tax situation.	Carefully consider your current and projected future tax bracket when choosing between a Traditional and Roth IRA. Consult a tax advisor if unsure.
Forgetting to invest the money	Your money sits in cash, losing purchasing power to inflation, and missing out on potential growth.	Once your IRA is funded, immediately select investments that align with your goals. Set up automatic investments if possible.
Making inconsistent contributions	You save less than you intended, potentially falling short of your retirement goals and missing out on compounding growth.	Set up automatic recurring contributions from your bank account to your IRA.
Ignoring fees and expenses	Fees can significantly erode your investment returns over the long term, even with good market performance.	Research and compare fees (account maintenance, transaction, expense ratios) across different IRA providers. Opt for low-cost funds and platforms.
Withdrawing money before retirement age	You face significant penalties (typically 10%) and income taxes on the withdrawn amount, drastically reducing your retirement nest egg.	Understand the rules for early withdrawals. Only use your IRA for retirement, or explore qualified exceptions (e.g., first-time home purchase, certain educational expenses) if absolutely necessary.
Not rebalancing your portfolio	Your investment mix drifts over time, potentially exposing you to more risk than you’re comfortable with as market values change.	Periodically review and rebalance your IRA’s asset allocation to maintain your desired risk level and investment strategy.
Failing to track contribution limits	You may contribute more than allowed, leading to IRS penalties for excess contributions.	Be aware of the annual IRS contribution limits for IRAs and ensure your total contributions do not exceed them.
Investing too conservatively early on	You miss out on potential long-term growth that could have been achieved through a more growth-oriented strategy when you have a long horizon.	Align your investment strategy with your time horizon. Younger investors with decades until retirement can generally afford to take on more risk for higher potential returns.
Investing too aggressively near retirement	You risk significant losses close to when you need the money, jeopardizing your retirement security.	Gradually shift to a more conservative investment mix as you approach retirement age to preserve capital.

Decision Rules (Simple If/Then)

• If your current tax rate is higher than you expect it to be in retirement, then consider a Traditional IRA because you’ll get a tax deduction now when it’s more valuable.
• If you expect your tax rate to be higher in retirement than it is now, then consider a Roth IRA because your withdrawals will be tax-free in retirement when taxes are higher.
• If you have a stable income and can afford it, then set up automatic monthly contributions to your IRA because consistency is key to long-term saving.
• If you have a large sum of money available, then consider contributing the maximum allowed for the year to your IRA before the deadline because it maximizes your tax-advantaged savings potential.
• If you are under age 50, then contribute up to the IRS annual limit because you want to maximize your tax-advantaged savings.
• If you are age 50 or older, then contribute the standard IRS limit plus the catch-up contribution because you have an opportunity to save more for retirement in your later working years.
• If you are unsure about your risk tolerance, then start with a more conservative investment allocation within your IRA because it’s easier to increase risk later than to recover from significant losses.
• If you are investing in individual stocks, then ensure you are also diversified across sectors and company sizes because this reduces company-specific risk.
• If you are nearing retirement (within 5-10 years), then gradually shift your IRA investments towards more conservative assets like bonds because preserving capital becomes more important.
• If you experience a significant life event (e.g., job change, inheritance), then review your IRA contributions and investment strategy because your financial situation may have changed.
• If you have a high-deductible health plan, then consider opening a Health Savings Account (HSA) in addition to your IRA because HSAs offer triple tax advantages and can be used for healthcare expenses in retirement.
• If you are self-employed or a small business owner, then explore options like a SEP IRA or Solo 401(k) because these plans often allow for higher contribution limits than traditional IRAs.

FAQ

What are the IRS contribution limits for IRAs?

The IRS sets annual limits for IRA contributions. These limits can change year to year and may differ for those under and over age 50 (due to catch-up contributions). Check the official IRS website or your IRA provider for the most current figures.

Can I contribute to both a Traditional and a Roth IRA?

Yes, you can contribute to both types of IRAs in the same year, but your total contributions to all your IRAs cannot exceed the annual IRS limit. Your eligibility for a Roth IRA may also be subject to income limitations.

What is the deadline for making IRA contributions?

The deadline to make contributions for a given tax year is typically April 15th of the following year. For example, contributions for the 2023 tax year can be made until April 15, 2024.

What happens if I contribute too much to my IRA?

Contributing more than the IRS limit results in an excess contribution. You will typically have to pay a 6% excise tax on the excess amount each year it remains in the IRA. It’s important to correct this mistake by withdrawing the excess amount and any earnings on it.

Can I withdraw money from my IRA before retirement age?

Yes, but generally, you will owe a 10% penalty tax on the amount withdrawn, in addition to regular income tax, if you are under age 59½. There are some exceptions, such as for qualified higher education expenses, first-time home purchases, or significant medical expenses.

How do I choose which investments to buy within my IRA?

Your investment choices should align with your time horizon and risk tolerance. Common options include low-cost index funds, ETFs, mutual funds, bonds, and individual stocks. Target-date funds are a popular choice for hands-off investors.

What is “rebalancing” an IRA?

Rebalancing involves adjusting your investment portfolio periodically to bring it back to your target asset allocation. For example, if stocks have grown significantly and now represent a larger portion of your portfolio than intended, you would sell some stocks and buy more bonds to return to your desired mix.

Do I have to pay taxes on IRA contributions?

For Traditional IRAs, contributions may be tax-deductible in the year they are made, reducing your taxable income. For Roth IRAs, contributions are made with after-tax money, meaning they are not tax-deductible. However, qualified withdrawals in retirement are tax-free.

What this page does NOT cover (and where to go next)

• Specific investment recommendations or advice on choosing individual stocks or bonds.
• Detailed tax strategies or advice on complex tax situations, including estate planning.
• The nuances of employer-sponsored retirement plans like 401(k)s, 403(b)s, or defined benefit pensions.
• The process of rolling over funds from another retirement account into an IRA.
• International retirement savings accounts or regulations.
• Advanced investment strategies such as options trading or margin accounts within an IRA.