Whether you’re contributing to a traditional IRA, Roth IRA, or a combination, the 2021 contribution limit is $6,500, or $7,500 for those aged 50 and older. There are some restrictions, based on income and whether or not you’re covered by a retirement plan at work, that may affect how much you can contribute.

Both traditional and Roth IRAs can be an excellent part of your financial plan, as both carry tax benefits. With a traditional IRA, you get a tax deduction on the money you save, and the money you take out in retirement is taxable. A Roth IRA works the opposite – you don’t get any tax deduction now, but the money you take out in retirement is tax free.

Before you decide where you want to save your money this year, take a look at your overall financial plan. Money put aside in an IRA or other type of retirement account should only be used for retirement, and there are penalties for taking money out early, so don’t put in more money than you’re comfortable. You should also consider whether it makes more sense to pay off debts before retirement – you may end up saving more money by not paying interest than what you would’ve gained from investment accounts.

Contributing “earned income”

Any money that you contribute to an IRA must be “earned income” – money that you get from working a job or being self-employed, including wages, bonuses, commissions, and tips, or from owning a business. Disability retirement benefits also count as earned income until you hit the minimum retirement age.

Other types of income, like from alimony, child support, owning rental properties, and unemployment benefits, don’t count as “earned income” in the eyes of the IRS.

If you’ve earned less money in a year than the current contribution limit, that amount becomes the maximum you can contribute. For example, if you earned $12,000 from a rental property and $4000 from a freelance job, the maximum you could contribute to any form of IRA is $4000.

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Spousal IRAs

There is a workaround to this requirement for families where one spouse doesn’t earn income. It’s called a “Spousal IRA.” Whoever is earning income can open up an IRA for their spouse, and contribute income that they’ve earned. The working spouse can contribute up to the limit in both IRAs for themselves and for their spouse, as long as they have enough earned income to cover both (in 2023, that would be $13,000 in earned income).

Salary limits

Depending on how much you earn, the maximum you’re allowed to contribute to an IRA may be reduced or eliminated entirely.

There are no salary limits on a traditional IRA as long as neither you nor your spouse are covered by a retirement plan at work, such as a 401(k). However, if you or your spouse are covered by a retirement plan at work, your tax deduction may be reduced or eliminated.

Roth IRAs, on the other hand, have simpler salary limits. If you earn over a certain amount, the amount you contribute is reduced or eliminated entirely.

If you go over your salary limit or the general contribution limit, you’ll have to pay a 6% fine every year on that money until you fix it, so make sure you’re not contributing too much in a given calendar year.

Everyone’s retirement plan is different, and a strategy that works for a friend or neighbor may not work for you. Talk to a Certified Financial Planner at Retirable today for advice on your specific finances and ensure that you’re making the best decision for you and your family.

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