Retirement contributions can feel like a complicated thing. And when you dig into the nitty-gritty details, that is exactly how it can seem. But how do you know how many contributions you can make, and when? And how do you gauge whether you would prefer to put aside tax-deductible retirement contributions, or make so-called “after-tax” contributions instead? To better understand these questions, let us look at how you can think about Self-Directed IRA contributions in a way that makes sense.
Deductible or Non-Deductible? A Primer on Self-Directed IRA Contributions
One of the most important things to understand about Self-Directed IRA contributions is that they will generally fall into one of two categories. There are tax-deductible contributions, and non-tax-deductible contributions. How can you tell the difference? You can start by looking at the type of account. For example, a Self-Directed Roth IRA can have a limited amount of non-deductible contributions. Many people call this “after-tax” money, since you are using money from income that was already taxed to put aside for retirement. The advantage of putting these types of contributions away for retirement is that when they are already taxed, you do not owe taxes on withdrawals upon entering retirement age, provided all of the requirements are met.
With deductible contributions, you can put “before-tax” money aside for retirement. The tax deduction in this case would lower the taxable amount of money you earned in the year when you made the contributions. In other words, you are able to save some money on your tax bill by putting some of your income aside for retirement. However, because this is “before-tax money,” you will then be expected to pay taxes on it when you withdraw it in retirement.
Contribution Limits in Self-Directed IRAs
Of course, no talk about contributions for retirement is complete unless we address contribution limits. For Traditional and Roth IRAs, contribution limits are similar. As the IRS states, the contribution limits for both Traditional and Roth IRAs in 2019, 2020, and 2021 are all the same: up to $6,000 for each year. That number can increase to $7,000 for additional catch-up contributions if a retirement investor has passed a certain age.
However, keep in mind that these limits do not necessarily apply to rollover contributions or qualified reservist payments, as the IRS notes.
What Happens if You Go Over the Contribution Limit?
If you did not calculate things the right way, there is the possibility that you will have to pay a penalty tax on contributions that go over your limit. This is known as an “excess IRA contribution.”
“Excess contributions are taxed at 6% per year for each year the excess amounts remain in the IRA,” notes the IRS, as we linked above. “The tax can’t be more than 6% of the combined value of all your IRAs as of the end of the tax year.”
That means that investors who want to be shrewd about the way they invest their money should always know about the Self-Directed Roth IRA and Self-Directed Traditional IRA contribution limits, as well as the rules that surround these limits. It is possible that your limit can be different depending on your age, for example.