Turn Holiday Cash Into Retirement Savings | American Funds

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DECEMBER 26, 2016

If the Holiday Season Brings Some Cash, Consider Making a Max IRA Contribution

The maximum IRA contribution for 2016 is $5,500. Here’s why you might want to consider socking away dollars in this tax-advantaged retirement account.

$5,500IRA contribution limit for 2016

Did you receive any cash gifts during the holiday season? Before you head off to make non-essential purchases, consider putting those dollars to work for your retirement by contributing to an IRA.

You have until April 17, 2017, to make a contribution to an IRA and make it count toward your 2016 tax return. The IRA contribution limit for 2016 is $5,500, with an additional “catch-up” contribution of $1,000 allowed for those age 50 and above.

Money invested in IRAs grows either tax-deferred or tax-free, allowing more of your money to compound each year. And depending upon the type of IRA you choose, these retirement accounts offer other tax advantages. Even if you have a 401(k) at work, you might want to tuck away additional retirement dollars in an IRA.

There are two main types of IRAs: traditional IRAs and Roth IRAs, each with different features, eligibility rules and restrictions.

One of the key distinctions between the two comes down to when you pay taxes on your investments.

With a traditional IRA, contributions are made before taxes and can be deductible. Earnings grow tax-deferred until you begin taking distributions, which are taxed as ordinary income. Anyone with earned income who is under age 70½ can contribute to a traditional IRA.

With a Roth IRA, contributions are made with after-tax dollars. So you don’t get a tax deduction when you contribute, but you won’t be taxed later on qualified distributions. As a result, Roth IRAs might make more sense for people who expect to be in a higher tax bracket when they retire. Unlike traditional IRAs, you can contribute to a Roth IRA only if your income falls below certain limits.

You might want to take your holiday cash and pay it forward by starting an IRA for your child. Regardless of age, a child is allowed to contribute to a traditional IRA or a Roth IRA so long as the child meets the earned income requirement.

Consider what could happen if you invested $5,500 in your child’s IRA and didn’t touch it for 50 years. Assuming a 7% annual return compounded annually, the account would be worth $162,000.

It could be a gift that just keeps giving.

Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.

Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing. 

Past results are not predictive of results in future periods.