Generally, the more money you deposit in an IRA, the better. Money you contribute to a traditional IRA, up to the legal limit, is usually free from income tax, and so are your earnings until you withdraw them. The higher your tax rate, the more tax your IRA contributions save you, and the more your account can grow for retirement. Still, weigh your IRA contributions against other demands on your wallet.
If you can afford it and you don't have higher priorities, contribute the maximum to your traditional IRA: $5,000 a year in 2012, $5,500 in 2013, slightly more if you're over 49. If you earn less than that, you can only contribute up to your earnings. If your spouse earns enough to max out her IRA but you don't, however, she can deposit extra money in your account. That way, the two of you can max out both accounts.
IRA vs 401(k)
If you have a 401(k) as well as an IRA, the workplace plan is often the one to deposit money in first. Employer-matched funds make a big difference. If your employer matches 401(k) contributions up to 6 percent of your salary, say, or even matches half your contribution, getting that free money should be your top priority. If you have investment funds left after contributing to the match limit, then go to your IRA. The amount you contribute to a 401(k) doesn't affect how much you can contribute to your IRA.
IRA vs Debt
Paying down your debts is another form of investment. If you pay, say, $5,000 on a credit-card balance with 12 percent interest, that's as good as investing the money at a 12 percent return. Financial writer Suze Orman recommends you reduce your IRA contribution to pay off your high-interest debts faster, but don't stop feeding your IRA entirely. As your monthly debt payments shrink, put more money into your retirement fund.
If you have a 401(k) and a high adjusted gross income -- $58,000 as of 2012 -- that reduces the amount you can contribute to an IRA tax-free. You can still contribute to your IRA, but not tax-free. Even though your earnings still grow free of tax, the financial gain from after-tax contributions is smaller. In that situation, maxing out your 401(k) contributions even when there's no employer match to compensate, should come first.
- CNN Money: How Much Should I Put Into an IRA?
- Internal Revenue Service: Traditional IRAs
- Charles Schwab: http://www.schwab.com/public/schwab/resource_center/expert_insight/retirement_strategies/planning/saving_for_retirement_ira_vs_401k.html
- Oprah.com: Suze on Debt
- FI Guide: Should I Make Nondeductible IRA Contributions?
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.