My First Financial Change in 2013: Roth IRA Contribution Increase

by Kevin on January 5, 2013

I told you that I always wrap up my financial year by looking to the future and reassessing my goals.

What is the first major change you will make this year after looking forward?

For me, theĀ first major change is an increase in retirement account contributions. The contribution limit for Roth IRAs is finally going up. The last time there was a contribution limit increase for Roth IRAs was in 2008 when it was raised from $4,000 to $5,000 per person per year. Since we didn’t start seriously saving for retirement until February 2008 this is the first contribution increase we’ve been able to experience.

Now the limit has been increased by $500 to $5,500 per person per year.

This isĀ huge news for retirement savers. Even though the amount of the increase seems small it can lead to a much larger nest egg if you start early enough.

Nest Egg Size with Higher Roth IRA Contribution Limits

Exactly how much bigger could your nest egg be with the 2013 Roth IRA contribution limit in place? Let’s find out.

My wife and I each max out our Roth IRAs each year, but I’ll do the math before for single individuals and married couples. We’ll also add in the $1,000 extra contribution per person once you hit age 50.

If you start at age 30 and save until age 65 while earning 7% annually on the money (which is impossible to achieve every year; one year it will be 12% and the next year 2%, and so on), you will end up with the following nest egg amounts:

  • With $5,000 contribution + $1,000 after age 50: $766,455.35 if you are single
  • With $5,000 contribution + $1,000 after age 50: $1,532,910.71 if you are married

Not a bad start to a comfortable retirement, especially if you have other retirement income sources like Social Security, a 401k, or rental property.

But with the small $500 increase in the contribution limit you can grow your nest egg to this:

  • With $5,500 contribution + $1,000 after age 50: $840,412.08 if you are single
  • With $5,500 contribution + $1,000 after age 50: $1,680,824.17 if you are married

That’s a big difference:

  • $73,956.73 for singles
  • $147,913.46 for married couples

But the price of admission was much smaller than that:

  • 35 years x $500 extra contribution for singles: $17,500
  • 35 years x $500 extra contribution x 2 people for couples: $35,000

The Best Part About Higher Roth IRA Contribution Limits

You know having a larger nest egg is great, and you know putting more money into your Roth every year is smart. But what really makes this a great deal for savers like you and me is the taxation of your Roth IRA nest egg.

“What taxation? I thought when I withdraw my Roth IRA funds in retirement they would be free of income tax?”

Exactly.

The simplicity of the Roth IRA (and its cousin the Roth 401k) is that you go ahead and pay taxes now. Pay them now, pay them later, it doesn’t really matter unless tax rates change significantly (which I think they have a good chance of doing). But I’ll gladly pay them now to know that the number I see on my retirement account total is the actual total amount of money I have to spend in retirement.

It makes retirement planning so much easier to comprehend. I don’t have to say “Okay… I have $2 million in my nest egg, but I’ll pay anywhere from 15% to 25% of my income, maybe, unless rates change, on that amount, which leaves me with somewhere between $1.5 million and $1.7 million…”

I just look at it and say, oh, sweet, I have $2 million for retirement. No more math needed.

Either way you go — your Traditional IRA contribution went up by the same amount — the more money you put aside now the better off you will be in the future. And that’s a deal too good to pass up.

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