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2011 IRA contribution limits: 3 ways to maximize your retirement tax advantages

By Richard Barrington

2011 IRA contribution limits: 3 ways to maximize your retirement tax advantages

Have you ever run a long-distance race?

I find it useful to think of saving money like distance running. If you obsess over the total distance, then each step seems hopelessly insignificant in covering the necessary ground. If instead you just start making those steps, and concentrate on finding a comfortable and consistent pace, you'll find that before you know it, the distance will take care of itself.

In other words, focus on the next step, because that is what you can most directly control.

In terms of saving money, a great way to make that next step is with a contribution to an IRA -- either a traditional or a Roth IRA. To help you make that step, there are a few things you should know about IRAs, including important information on IRA contribution limitations for this year.

1. Traditional and Roth IRA contribution limitations

Both traditional and Roth IRAs have certain tax advantages, which will be discussed below in "Deciding on a traditional vs. a Roth IRA." However, for anyone considering starting an IRA this year or making continued contributions into an IRA account, it's critical to know that there are limits on how much you can contribute to IRAs each year.

To start with the simple part, the basic contribution limits for both traditional and Roth IRAs are the same, and are unchanged for 2011. The only difference is that taxpayers who are aged 50 and over are allowed to make higher, "catch-up" contributions.

IRA Contribution Limits

Age GroupTraditional IRARoth IRA
Under 50$5,000$5,000
50 or Over$6,000$6,000

Note that these limits apply to total IRA contributions, so if you have multiple IRAs, including both a traditional and a Roth IRA, any amount you contribute to one reduces the amount you are able to contribute to the other.

Another limitation is that the amount you contribute to an IRA cannot exceed your taxable income for the year. That seems simple enough, but there are complications for higher earners. Depending on your tax status and income bracket, your eligibility to make IRA contributions might be reduced -- or eliminated altogether.

2. Income ceilings for traditional and Roth contributions

For both traditional and Roth IRAs, there is an income level at which the amount you can contribute starts to be reduced, and a level at which it is eliminated completely. This is known as a contribution phase-out.

With traditional IRAs, this applies only if you or your spouse were covered by an employer-sponsored retirement plan during the tax year for which you are making the IRA contribution. For Roth IRAs, however, the contribution phase-outs apply to anyone who falls within the applicable income limits.

Income parameters for deduction phase-outs are described in the tables below. In each case, eligible contribution amounts start to be reduced at the lower end of the ranges given, and are eliminated altogether at the upper end of those ranges:

Traditional IRA deduction phase-outs

Tax Status2010 Deduction Phase-Out Range2011 Deduction Phase-Out Range
Single or head of household, participating in an employer-sponsored retirement plan$56,000 to $66,000$56,000 to $66,000
Married, filing jointly, and participating in an employer-sponsored retirement plan$89,000 to $109,000 (combined household income)$90,000 to $110,000 (combined household income)
Married, filing jointly, and spouse participates in an employer-sponsored retirement plan$167,000 to $177,000 (combined household income)$169,000 to $179,000 (combined household income)

Roth IRA contribution phase-outs

Tax Status2010 Contribution Phase-Out Range2011 Contribution Phase-Out Range
Single or head of household$105,000 to $120,000$107,000 to $122,000
Married, filing jointly$167,000 to $177,000 (combined household income)$169,000 to $179,000 (combined household income)
Married, filing separately, but lived with spouse at any time during the year$1 to $10,000$1 to $10,000

3. Deciding on a traditional vs. a Roth IRA

So, should you be contributing to a traditional or a Roth IRA? These three key differences can help you decide:

  1. Contributions to traditional IRAs are tax-deductible, but distributions from them are taxed, whereas the reverse is true for Roth IRA (as long as distribution guidelines are followed).
  2. For traditional IRAs, distributions before you are aged 59 1/2 not only are taxed, but are also subject to a 10 percent penalty, whereas a Roth IRA allows for certain exceptions, such as for buying a first home or in the case of disability.
  3. Traditional IRAs require you to start taking distributions after you reach age 70 1/2, whereas you are not required to take distributions from a Roth IRA at any time.

In some ways, this makes a Roth IRA ideal for younger savers who might feel they are in a lower tax bracket now than they will be in when they retire (and thus they would prefer to pay taxes now and get IRA distributions tax-free later). Also, younger savers might like the flexibility of being able to withdraw money from a Roth IRA to buy a home.

Whichever IRA you choose, the important thing is to start contributing to one this year so that you can start harnessing the power of compound interest and make your money work for you. The tax man even gives you a little leeway -- IRA contributions for the 2010 tax year don't have to be made until April 15, 2011. If retirement saving is like a long-distance race, that leeway can help you get a little bit of a head start.

Richard Barrington has earned the CFA designation and is a 20-year veteran of the financial industry, including having previously served for over a dozen years as a member of the Executive Committee of Manning & Napier Advisors, Inc. Richard has written extensively on investment and personal finance topics.

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