The Internal Revenue Service announced that it’s raising the 2012 contribution limits for some types of retirement accounts.
“Huh? What’s she talking about?” – if that first paragraph sounded like jargon, here’s the background.
(If you understood that first paragraph, you can skip the “Background” section and go straight to the list of 2012 contribution limit increases, which I’ve posted below.)
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There are a handful of different accounts that help you save for retirement.
The most popular is the 401k account, which is offered by many employers. The money that you put in your 401k is called your “contribution.” This contribution is made with pre-tax money. This means that instead of paying income tax on your contribution now, you’ll pay taxes years down the road when you withdraw that money.
If you’re self-employed, and your business has no common-law employees other than your spouse, you can set up an Individual 401k for yourself. This is sometimes referred to as a Solo 401k.
You have a choice of contributing either pre-tax dollars or after-tax dollars to your Solo 401k.
If you want to contribute after-tax dollars – meaning you pay taxes this year, but you don’t have to pay taxes when you withdraw the money in retirement – your account will be called a Roth Solo 401k or a Roth Individual 401k.
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There are four main types of Individual Retirement Accounts, or IRA’s: The SIMPLE IRA, the SEP-IRA, the Traditional IRA and the Roth IRA.
The Traditional IRA is also funded with pre-tax dollars, while the Roth IRA is funded with after-tax money. (Here’s a helpful hint: anytime you hear the word “Roth,” it indicates “after-tax dollars.”)
You’re allowed to chip in a maximum of $5,000 per year (in the year 2012) to a combination of your Traditional IRA and Roth IRA accounts. If you’re 50 or over, you can chip in an extra $1,000 on top of that limit.
In other words, your yearly contribution to your Roth IRA plus your Traditional IRA can’t be greater than $5,000 if you’re 49 or under, or $6,000 if you’re 50 or over.
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For example: Sally, age 25, contributes $5,000 to her Roth IRA. She is not allowed to contribute anything to her Traditional IRA in that same year.
John, age 57, contributes $2,000 to his Roth IRA and $4,000 to his Traditional IRA.
And Benny, age 44, contributes $4,999 to his Roth IRA and $1 to his Traditional IRA.
You can establish both a Traditional IRA and Roth IRA account yourself. By contrast, only your employer can set up a SEP-IRA for you. SEP-IRA’s are often used by self-employed people or small businesses.
Your employer can contribute up to 25 percent of your wages to a SEP-IRA – so if you are paid $80,000, your employer can contribute $20,000 to your SEP-IRA.
The SIMPLE IRA is also used by small businesses with 100 or fewer employees. Contributions to the SIMPLE IRA are made with pre-tax dollars.
Read more: How a Tax Refund Can Cost You More
2012 Contribution Limit Increases
As I mentioned in the first paragraph, the IRS announced it’s raising the contribution limit on some retirement accounts for 2012. Here are the new limits:
401k – Increase from $16,500 to $17,000
The IRS is raising the contribution limit to your 401k from $16,500 (the 2011 limit) to $17,000 (the 2012 limit). This applies to both Roth and Traditional 401k plans. It also applies to the 401k’s close cousins, called the 403b and the 457.
If you’re 50 or over, you can add an extra $5,500 to that maximum – for a total of $22,500 that you can stash away in a 401k.
SEP-IRA – Increase from $49,000 to $50,000
In 2011, your employer was allowed to contribute a maximum of $49,000 to your SEP-IRA. In 2012, that limit is raised to $50,000.
Just be cautious – you’re only allowed to contribute a maximum of 25 percent of your net profit, up to a maximum dollar amount of $50,000. The maximum number of raw dollars you’re able to contribute to a SEP-IRA increased, but the percentage of your net profit that you can devote to your SEP-IRA is the same.
Traditional and Roth IRA, SIMPLE IRA – Stayed the Same
No changes here. You can only contribute $5,000 to a combination of your Traditional and Roth IRA, or $6,000 if you’re 50 or over. You can contribute $11,500 to a SIMPLE-IRA, or $14,000 if you’re 50 or over.
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