Good news if you are close to paying off debt before you move on to investing or if you’re just a regular old procrastinator: Even though 2020 is ending tomorrow, you still have until tax day 2021 to make contributions to your IRA using the 2020 contribution limit.
Sometimes new investors get confused about the logistics of these contribution limits, so here’s how it works:
Opening up an IRA (stands for Individual Retirement Account) is pretty simple. Basically like opening up a savings account. But there are some special rules about this account. Notably, any GROWTH that occurs within the account (e.g. buying stocks that go up in value) is NEVER taxed. That can add up to a huge tax savings. But in exchange for that tax break, you basically have to leave it in there until you’re 59.5 years old.
One other rule is that they limit how much money you’re allowed to put in each year. In 2020 that’s $6,000.
So you open an account, then you can deposit up to $6,000 during one year (all at once, or a little at a time, whatever you prefer). Next year (2021) you can put another $6,000 in. It doesn’t go into a new account, you put it into the same account. Once the money is safely inside, it can grow to an unlimited size. So if you’re contributing $6K per year and get a 10% return on the investments inside, 40 years later your Roth IRA will have a cool $2.6 million!
From January 1st until April 15th when you contribute to your Roth IRA your brokerage will give you a CHOICE. Do you want your contribution to count toward the 2020 or 2021 limit? Always choose the older year because that contribution limit is “use it or lose it”. You’ll have another year to fill up the 2021 limit.
One last note: Your Roth IRA is NOT an investment. It’s an account in which you buy investments. So after you put your money in, make sure to take the next step and buy an investment.
As always, reminding you to build wealth by following the two PFC rules: 1.) Live below your means and 2.) Invest early and often.