Net Gains: Retire With a Larger Nest Egg

Jan. 16, 2008 — -- Saving for retirement got a bit easier two weeks ago.

New IRA contribution limits that took effect Jan. 1 allow individuals to set aside an extra $1,000 a year in traditional and Roth IRAs. That brings the annual limits to $5,000 for anyone under age 50 and $6,000 for those 50 and over.

An extra $1,000 a year might not sound like a big deal, but for a 40-year-old planning to retire at 65, it could mean an extra $79,000 available at retirement, assuming their IRA investments average an 8 percent annual return.

The new limits are the last big step up in IRA limits brought about by the Economic Growth and Tax Relief Reconciliation Act of 2001. When that legislation passed Congress in May 2001, the maximum anyone could contribute to an IRA was $2,000.

EGTRRA, as the 2001 act is referred to in tax circles, established a timetable for increasing maximum IRA contributions in three, $1,000 increments, with future increases indexed to inflation. It also created catch-up contributions for individuals 50 and over. The catch-up contribution limit remains unchanged at $1,000 a year.

The higher limits had been set to expire in 2010, but the Pension Protection Act of 2006 made permanent the higher contributions to IRAs, 401(k) plans and other retirement savings plans.

Be aware the contributions limits for most other retirement savings plans -- 401(k), 403(b), 457 and SIMPLE IRA -- are not increasing this year. They are already tied to inflation. One other plan type into which higher contributions will be allowed this year is the SEP IRA. The maximum employer's contribution to a SEP -- used primarily by self-employed individuals -- is $46,000 this year, up $1,000 from last year.

What do the higher IRA contribution limits mean for retirement savers?

It means now is the time to adjust how much you direct to your IRA on a monthly or quarterly basis. If you are someone who contributes the maximum amount through a monthly automatic investment plant, you can add an extra $83.33 to your monthly contribution.

For contributors under age 50, your monthly target is $416.66. You can toss in the extra 8 cents at the end of the year. For those 50 and over, the new target is an even $500 a month.

Keep in mind, there are some restrictions on IRA eligibility. For traditional IRAs, the restrictions limit who qualifies for a tax deduction on their contributions. For Roth IRAs, there are income limits on who can contribute at all.

The good news is that due to inflation indexing, the income eligibility limits also increased on Jan. 1.

I will not go into detail about all the new eligibility guidelines here, but here is an example. For a Roth IRA, a married couple filing jointly with modified adjusted gross income up to $159,000 can make the maximum allowed contribution. A couple with adjusted gross income between $159,000 and $169,000 will qualify for a portion of the Roth limits. Above $169,000 for a married couple, no Roth IRA contributions are possible.

For more detail on IRA income limits, see IRS Publication 590. The 2007 edition contains details for 2008 contributions.

In addition to a larger retirement nest egg, the higher IRA contribution limit means tax savings now for contributors to a traditional IRA who qualify for a deduction. For somebody in the 25 percent tax bracket, the extra $1,000 on the limit translates into a $250 federal income tax savings this year.

The Roth contributor receives no deduction now, but will reap even greater tax savings down the road when the money and its accumulated earnings are withdrawn tax free in retirement.

As with all tax changes, these higher limits will take some time for many retirement savers to take notice. Consider yourself an early adopter, and give your IRA savings a $1,000 boost this year.

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

David McPherson is founder and principal of Four Ponds Financial Planning (www.fourpondsfinancial.com) in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at david@fourpondsfinancial.com