Did you know the government will essentially give you between $550 and $2,405 to invest in your own future? While this may sound like the start of a bad infomercial promising free government money, the opportunity to get this money is very real and open to millions of Americans — yet only 30% of U.S families are taking advantage of it, according to recent studies from Employee Benefit Research Institute.
Where does this free money come from? It comes from a tax break for making annual contributions to a traditional IRA.
Provided that your taxable income isn’t too high, you can claim a tax deduction of up to $5,500 for making IRA contributions in 2018 — $6,500 if you’re 50 or older.
Depending on your tax rate and age, this deduction could be worth between $550 and $2,405.
So, how can you claim this tax break? Do two things: Open a traditional IRA and make the maximum contribution.
Read on to find out why it’s so important to have an IRA and how to do both tasks.
Why is it so important to have an IRA?
Opening an IRA is important because IRAs and 401(k)s are the two primary retirement accounts offering tax breaks for retirement. While not everyone has access to a workplace 401(k), almost anyone can open an IRA and make tax-deductible contributions.
If neither you nor your spouse has a workplace retirement plan, you can contribute to an IRA regardless of your income. If you or your spouse have a workplace plan, eligibility for IRA deductions phases out if you earn too much. You can check out the specific income limits, but unless you make at least $63,000 as a single person or $101,000 as a married couple filing jointly, you’re eligible no matter what.
Tax breaks are available for investing in two different kinds of IRAs. A traditional IRA gives you a break upfront in the form of a tax deduction the year you invest. A Roth IRA gives you a tax break during retirement. You invest in a Roth IRA with after-tax dollars, but withdraw funds tax-free as a senior.
The tax savings you’ll enjoy is substantial when you invest in either IRA, but immediate tax savings from a traditional IRA makes it more affordable to save now. This table shows how much your tax break is worth for IRA contributions under different circumstances.
| Tax Rate | $1,000 Contribution | $2,000 Contribution | $3,000 Contribution | $4,000 Contribution | $5,000 Contribution | $5,500 Contribution | $6,500 Contribution |
|---|---|---|---|---|---|---|---|
| 10% | $100 | $200 | $300 | $400 | $500 | $550 | $650 |
| 12% | $120 | $240 | $360 | $480 | $600 | $660 | $780 |
| 22% | $220 | $440 | $660 | $880 | $1100 | $1210 | $1430 |
| 24% | $240 | $480 | $720 | $960 | $1200 | $1320 | $1560 |
| 32% | $320 | $640 | $960 | $1280 | $1600 | $1760 | $2080 |
| 35% | $350 | $700 | $1050 | $1400 | $1750 | $1925 | $2275 |
| 37% | $370 | $740 | $1110 | $1480 | $1850 | $2035 | $2405 |
Table calculations: Author
Of course, the tax break isn’t the only reason to invest. Your IRA should provide a generous nest egg. Consider how much your IRA could be worth if you invest $5,500 each year at 7% until age 67 and earn 7% on investments.
| Age You Start Investing | IRA Balance at 67 |
|---|---|
| 30 | $881,855.00 |
| 35 | $606,199.00 |
| 40 | $409,661.00 |
| 45 | $369,531.00 |
| 55 | $98,386.00 |
Table calculations: Author.
With the government subsidizing your investment, saving $5,500 or $6,500 each year becomes easier — and the payoff is definitely worth it.
Here’s how you open an IRA
If you’ve determined you can make tax-deductible contributions, it’s time to open an account. You can open an IRA with brokerage firms, mutual fund companies, banks, or roboadvisors.
- Brokerage firms give you the widest choice of investment options and you can find discount brokers online with very small fees to buy and sell investments. You can invest in individual stocks, mutual funds, exchange-traded funds (ETFs), and other assets — but you’ll need to be comfortable making your own investment choices. There are simple approaches to building your own portfolio of investments that will allow you to minimize fees and balance risk.
- Roboadvisors such as Wealthfront and Betterment handle investing for you for a small fee, automating the process of choosing diversified investments based on risk tolerance but this comes at a cost.
- Banks and mutual fund companies provide much more limited investment choices so often aren’t the best option.
Opening an IRA online with a discount broker or roboadvisor takes only minutes. You’ll need to input your personal identifying information, including your Social Security number, and select how to fund your account.
Once you’ve put money in, you can purchase investments in your brokerage account or your roboadvisor will select investments for you. If you’re not sure where to start, check out some model portfolios or tips for investing in the stock market if you can’t pick stocks.
Here’s how you can max out IRA contributions
Once you’ve got your IRA, max out contributions to get the maximum tax benefits, and save enough for a secure retirement.
To invest $5,500 per year, you’d need to save around $106 per week. To invest $6,500 per year, you’d need $125. find this money, make a detailed budget to spot areas where you’re overspending. You may be able to cancel unused gym memberships, cut back on cable, skip a few meals out per month, or cut back on shopping. Making a budget helps you see where you can free up cash.
A side gig could also be an option. More than 44 million Americans have a side hustle, and almost 40% of those with side jobs earn more than $500 per month from them, according to a Bankrate survey. This would be enough to max out your IRA.
Whether you decide to cut your budget or increase your income, automating contributions to your IRA is a helpful way to hit target goals. Determine how much you can contribute and set up automatic contributions on payday, so money moves to your IRA before you get a chance to spend it.
Don’t miss out on a valuable tax break that makes it easier to invest in your future
If you’re in one of the 70% of American families not currently investing in an IRA, you’re missing out — but you can change that. Now you know how to open an IRA and can open one today. Even if you can’t contribute $5,500 right away, contributing something is better than nothing.
— Christy Bieber
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Source: The Motley Fool