When it comes to preparing for retirement, it’s very important to stay right up to speed with all the rules, regulations, and changes made by the IRS from year to year. With the next year looming just two months away, the IRS has made some 401(k) contribution limit changes for 2020 but still has left both Roth and traditional IRA contribution limits for 2020 flat.
The IRA limits are again unchanged from 2019’s $6,000, or $7,000 combined if you’re age 50 or older. This is the second straight year at those caps. The caps are the maximum amounts you can kick into those retirement accounts, whether you use just one type or in any combination. Before 2019, the IRA contribution limits stayed the same for six years in a row. So just in case you needed a refresher, today I thought I’d go over some of the things that you really need to know when you are saving in these accounts for your retirement!
Your 401(k) Account
For 2020, the IRS has nudged up the basic employee contribution limit for 401(k) accounts to $19,500. And it boosted the catch-up contribution for the first time in five years.
If you are 50 or older, you can kick in as much as an additional $6,500.
The combined limit would be $26,000. The limits apply to regular 401(k) accounts and to Roth-style accounts, if your plan permits them.
Roth-Style 401(k) accounts have different rules. The IRS calls a Roth-style account a designated Roth account.
All Roth accounts within your 401(k) take after-tax contributions. That means any money you put into a Roth 401(k) is not tax-deductible. That’s unlike contributions to a regular 401(k) account, which are deductible, reducing your taxable income. However, like withdrawals from a Roth IRA, withdrawals from a Roth 401(k) account are tax free.
(These same contribution limits apply to 403(b) plan accounts and to most 457 plans, as well as to the federal government’s Thrift Savings Plan for its workers.)
Your Own Contributions and Your Company Match
The $19,500 contribution limit for workers is separate from the cap on any employer contributions. If you are fortunate enough to have a company match, maximize it when offered if at all possible! This is free money that your employer is giving to you that comes as a dollar company match or a profit-sharing contribution that would take forever if at all for you to actually earn in interest or appreciation on your own. Never miss this opportunity when it’s offered!
In 2020, the combined cap on contributions by plan members and employers is now $57,000, or $63,500 for workers who are 50 or older.
What About Small Business Owners?
There is something called a Solo 401(k). This IRA is a 401(k) for Americans who own a small business that has no full-time employees other than themselves and/or their spouse.
The Solo 401(k) contribution limit is, basically, the same as it is for other types of 401(k) accounts. The combination of contributions by your business and your own salary contributions may not exceed $57,000 for 2020 or $63,500 if aged 50 or older. Those are up from $56,000 and $62,000 in 2019.
IRAs – What You Need to Know for 2020
The good news for any regular IRA holders out there is that there are no new rules to catch up on in 2020. IRA contribution limits for 2020 are unchanged. But, other than the contribution limits themselves, there is other red tape that restricts how much you can contribute and what you can deduct on your tax return. And, remember, you can deduct these retirement plan contributions even if you take the new, higher standard deduction instead of itemizing on your return.
Here are two key constraints on your ability to fund an IRA:
- Roth IRA contribution limits are reduced or eliminated at higher incomes.
- Traditional IRA contributions are deductible, but the amount you can deduct may be reduced or eliminated if you or your spouse is covered by a retirement plan at work.
Income-Based Limits on Deductibility
Here’s more about that second constraint. You can contribute to a traditional IRA and deduct that amount, up to the IRA contribution limit itself, from your taxable income no matter how high your income is. However, your right to do that is limited if you or your spouse is covered by a workplace retirement plan like a 401(k).
If you file taxes as a single taxpayer, your deductions are reduced as your income rises above $65,000. You are barred from taking any deduction if your income is above $75,000. For a married taxpayer filing jointly, the phase out of deductibility begins at joint income of $104,000 and ends at $124,000.
Roth IRAs vs. Traditional IRAs
The one major and most significant difference between Roth and traditional IRAs is that Roth IRA contributions are non-deductible. Traditional IRA contributions are deductible. The one that is right for you depends on several factors and is entirely debatable as well.
One factor to consider: Withdrawals from traditional IRAs are taxable while withdrawals from Roth IRAs are generally tax-free.
The times when a withdrawal from a Roth account is taxable comes when the withdrawal is less than five years old. In addition, the withdrawal is taxable if the owner is less than 59½ years of age.
But, even if the account is at least five years old and the owner is under age 59½, withdrawals are still tax-free if the account owner qualifies for an exemption. An account owner is exempt if he or she is completely and permanently disabled or deceased. In that last situation, the money goes to the deceased owner’s beneficiary.
The Pay-to-Play Rule of IRAs
Importantly, you must have “earned income” to contribute to an IRA. Earned income generally means wages, salaries, tips, bonuses, commissions, and self-employment income, but it can also include disability/retirement benefits.
The types of income that do not count as earned income include alimony, child support, and income from rental property as well as the interest and dividends from investments and Social Security benefits.
If you had earned income for 2020 of less than the IRA contribution limit, you can only contribute up to the amount you earned. For example, if you earned $4,000, the most you can contribute is $4,000.
Spousal IRA Contribution Limits
But there’s a legal loophole to that limit. If you don’t have any or enough earned income but your spouse does, you can have what’s known as a spousal IRA.
A person with earned income can contribute to that account for their spouse even when the spouse does not work for pay. To be eligible for a spousal IRA, you must be married and file a joint tax return.
You can set up a spousal IRA as a traditional or Roth IRA. In either case, the spouse with earned income can contribute to both spouses’ IRAs, provided they have enough earned income to cover both contributions. In other words, each IRA would have its own contribution cap.
Income Can Complicate 2020 Roth IRA Contribution Limits
You can contribute to a traditional IRA no matter how much money you earn. But you’re not allowed to open or contribute to a Roth IRA if you make too much money.
For example, if your 2020 taxpayer filing status is single, you can contribute up to $6,000 or $7,000 if you’re 50 or older without a problem if your modified adjusted gross income (MAGI) is less than $124,000. But if your MAGI is above that amount, then your contribution cap is lower. If it’s above $139,000, you’re barred altogether from contributing.
You may wonder why you should worry about all of the rules and regulations when it comes to retirement accounts. Especially if you are decades away from that big event. But the truth is that everyone wants to be in a good position financially when it comes to retirement and there is no way to get to that goal without good planning and understanding of what the options are for you. Keeping up with the changes and rules is a must!
The first step is getting the information from your employer about their offers and options. Second, find out what you can do without them on your own. Combining both types of retirement options and even a plan that may include pensions, annuities, and alternate streams of income can and will enable you to have the retirement you really want. The sooner you start planning it, the better off you will be!
How have you planned for your retirement and are you taking advantage of all of the options you need to insure it? What have you saved so far and where will you be when that big day occurs?