4 reasons to contribute to an IRA

Saving in an IRA comes with tax benefits that can help you grow your money.

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Key takeaways

  • Give your money a chance to grow.
  • Get tax benefits.
  • The earlier you start contributing, the more opportunity you have to build wealth.

It can pay to save in an IRA when you're trying to accumulate enough money for retirement. There are tax benefits, and your money has a chance to grow. The deadline for a 2017 traditional or Roth IRA contribution is the same as the 2017 tax-filing deadline—April 17, 2018—so time is running out to contribute for the 2017 tax year.

Why an IRA? An IRA is one of several tax-advantaged options for saving. If you have a retirement plan at work, an IRA could offer another tax-advantaged place to save.

If your employer doesn't offer a retirement plan—or you're self-employed—an IRA may make sense.

Read Viewpoints on Fidelity.com: No 401(k)? How to save for retirement.

Here are some reasons to make a contribution now

1. Put your money to work

Eligible taxpayers can contribute up to $5,500 per year to a traditional or Roth IRA, or $6,500 if they have reached age 50, for 2017 and 2018 (assuming they have earned income at least equal to their contribution). It's a significant amount of money—think about how much it could grow over time.

Consider this: If you're age 35 and invest $5,500, the maximum annual contribution in 2017 and 2018, that 1 contribution could grow to $82,360 after 40 years. If you’re age 50 or older, you can contribute $6,500, which could grow to about $17,900 in 15 years.1 (We used a 7% long-term compounded annual hypothetical rate of return and assumed the money stays invested the entire time.)

The age you start investing in an IRA matters: It's never too late, but earlier is better. That’s because time is an important factor when it comes to compound growth. Compounding is what happens when an investment earns a return, and then the gains on the initial investment are reinvested and begin to earn returns of their own. The chart below shows just that. Even if you start saving early and then stop after 10 years, you may still have more money than if you started later and contributed the same amount each year for many more years.

2. You don't have to wait until you have the full contribution

The $5,500 IRA contribution limit is a significant sum of money, particularly for young people trying to save for the first time.

The good news is that you don't have to put the full $5,500 into the account all at once. You can automate your IRA contributions and have money deposited to your IRA weekly, biweekly, or monthly—or on whatever schedule works for you.

Making many small contributions to the account may be easier than doing one big one.

3. Get a tax break

IRAs offer some appealing tax advantages. There are 2 types of IRAs, the traditional and the Roth, and they each have distinct tax advantages and eligibility rules.

Contributions to a traditional IRA may be tax-deductible for the year the contribution is made. Your income does not affect how much you can contribute to a traditional IRA—up to the annual contribution limit. But the deductibility of that contribution is based on income limits. If neither you nor your spouse are eligible to participate in a workplace savings plan like a 401(k) or 403(b), then you can deduct the full contribution amount, no matter what your income is. But if one or both of you do have access to one of those types of retirement plans, then deductibility is phased out at higher incomes.2 Earnings on the investments in your account can grow tax-deferred. Taxes are then paid when withdrawals are taken from the account—typically in retirement. Just remember that you can defer but not escape taxes with a traditional IRA: Starting at age 70½, required minimum withdrawals become mandatory, and these are taxable (except for the part—if any—of those distributions that consist of non deductible contributions).

On the other hand, you make contributions to a Roth IRA with after-tax money, so there are no tax deductions allowed on your income taxes. Contributions to a Roth IRA are subject to income limits.3 Earnings can grow tax-free, and, in retirement, qualified withdrawals from a Roth IRA are also tax-free. Plus, there are no mandatory withdrawals during the lifetime of the original owner.4

As long as you are eligible, you can contribute to either a traditional or a Roth IRA, or both. However, your total annual contribution amount across all IRA accounts is still $5,500 (or $6,500 if age 50 or older).

What's the right choice for you? For many people, the answer comes down to this question: Do you think you'll be better off paying taxes now or later? If, like many young people, you think your tax rate is lower now than it will be in retirement, a Roth IRA may make sense.

Need help deciding? Read Viewpoints on Fidelity.com: Traditional or Roth IRA, or both?

4. You may think you can't have an IRA, but make sure

There are some common myths about IRAs—especially about who can and who can't contribute.

Myth: I need to have a job to contribute to an IRA.

Reality: Not necessarily. A spouse with no earned income can contribute to a spousal Roth or traditional IRA as long as their spouse has earned income. Note, however, that all other IRA limits and rules still apply.

Myth: I have a 401(k) or a 403(b) at work, so I cannot have an IRA.

Reality: You can, with some caveats—as mentioned earlier. For instance, if you or your spouse contributes to a retirement plan—like a 401(k) or 403(b)—at work, your traditional IRA contribution may not be deductible, depending on your modified adjusted gross income (MAGI).2 But you can still make a nondeductible, after-tax contribution and reap the potential rewards of tax-deferred growth within the account. You can contribute to a Roth IRA, whether or not you have contributed to your workplace retirement account, as long as you meet the income eligibility requirements.3

Myth: Children cannot have an IRA.

Reality: An adult can open a custodial Roth IRA (also known as a Roth IRA for Kids) for a child under the age of 18 who has earned income, including earnings from typical kid jobs such as babysitting or mowing lawns, as long as this income is reported to the IRS.5

An adult needs to open and maintain control of the account. When the child reaches the age of majority, which varies by state, the account's ownership switches from the parent over to them.

Make a contribution

Your situation dictates your choices. But one thing applies to all: the power of contributing early. Pick your IRA and get your contribution in and invested as soon as possible to take advantage of the tax-free compounding power of IRAs.

Next steps to consider

Take advantage of potential tax-deferred or tax-free growth.

Determine if you're contributing enough to your savings.

See how small increases in contributions can add up over time.

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Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.

1. The hypothetical examples assume the following: one annual $5,500, or $6,500 IRA contribution, as applicable, made on January 1 of the first year; a 7% annual rate of return; and no taxes on any earnings within the IRA. The ending values do not reflect taxes, fees, or inflation. If they did, amounts would be lower. Earnings and pretax (deductible) contributions from a traditional IRA are subject to taxes when withdrawn. Earnings distributed from Roth IRAs are income tax free provided certain requirements are met. IRA distributions before age 59½ may also be subject to a 10% penalty. Systematic investing does not ensure a profit and does not protect against loss in a declining market. Consider your current and anticipated investment horizon when making an investment decision, as the examples may not reflect this. The assumed rate of return used in this example is not guaranteed. Investments that have potential for a 7% annual rate of return also come with risk of loss.
2. For a Traditional IRA, full deductibility of a contribution for 2017 is available to active participants whose 2017 Modified Adjusted Gross Income (MAGI) is $99,000 or less (joint) and $62,000 or less (single); partial deductibility for MAGI up to $119,000 (joint) and $72,000 (single). In addition, full deductibility of a contribution is available for working or nonworking spouses who are not covered by an employer-sponsored plan whose MAGI is less than $186,000 for 2017 partial deductibility for MAGI up to $196,000.
3. If you're single, or file as head of household, the ability to contribute to a Roth IRA for 2017 begins to phase out at MAGI of $118,000 and is completely phased out at $133,000. If you're married filing jointly, the phaseout range is $186,000 to $196,000.
4. A distribution from a Roth IRA is tax free and penalty free, provided that the five-year aging requirement has been satisfied and at least one of the following conditions is met: you reach age 59½, become disabled, make a qualified first-time home purchase ($10,000 lifetime limit), or die. Required minimum distributions do not apply to the original account owner, although heirs will be subject to them.
5. In general, anything that can be legitimately reported as taxable income on a form W-2 is acceptable (although the fact that the income is taxable doesn’t necessarily mean that taxes are paid—the amount could be below the child’s exemption). So money children earn on a paper route is OK, but money given to them by their parents as an allowance probably isn’t. Money earned by a child employed in a family business may be acceptable, but documentation will be required, and the amounts must be reasonable—you wouldn’t be able to claim to have paid your 10-year-old $300 for one hour of sealing envelopes. Always consult a tax expert when in doubt.
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