As individual taxpayers start to lay the groundwork for their annual filings in April, it's probably a good idea for the majority of filers with discretionary capital to go ahead and make their IRA contributions earlier this year.
Individual retirement accounts are a critical vehicle for providing retirement funds for those who don't have significant pension or 401(k) investment vehicles. Anyone who's self-employed, or who isn't making a single job into a life-long career, is likely to need an IRA to save money for retirement. These days, as public pensions get slashed to the hilt, this includes nearly everybody -- but especially anyone without a long-term nine-to-five, such as the growing community of the self-employed.
Some of the suggestions advanced by personal-finance advisors and others have to do with maximizing the yields of IRA investments and shrinking tax burdens as much as possible. That's the whole point of the IRA: The idea is that in their peak income years, professionals can sock away money tax-free. In a traditional IRA, they pay taxes when the money is removed, with the assumption that that person will be making less money in their golden years and will thus pay less tax on money that has been earning tax-free interest.
Timely IRA contributions
Suggestions for the average IRA investor are also based on some pretty substantial numbers that show a large percentage of contributors waiting until the very last weeks before filing to put money into their IRAs. According to MarketWatch, a five-year Vanguard Group survey of customers found that 41% of all savings are put into an account in the last four months of the investment window. Of that 41%, half of the money studied was dumped into accounts in those frantic two weeks before filing is due.
Why individuals contribute late
As some financial planners point out, there are legitimate reasons to make later contributions. This has to do with all of those last-minute calculations that individuals, families, and business partners make about their taxable income status right before filing, when they know more about how much they made and how much they can deduct. In some cases, financial advisors might tell clients to use this last-minute window to move money around in ways that will lower their tax burden.
Although some late contributions may be strategic, many of them are based on something much simpler: natural procrastination that, as many have learned first-hand, can create a lot of stress and headaches as the April filing date looms.
Gains and taxable interest
As for the rationale put forth for early contributions, two details tend to stick out. The first one is that IRA contributions start to accumulate tax-free gains as soon as they hit an account. That means even part of the year can make a difference in the eventual result in gains.
The other argument is that amounts that sit in non-IRA or conventional accounts will accumulate taxable interest over those months. With interest rates as low as they are, that's not much of a problem for individual depositors using consumer-facing commercial banks. For example, at a rate of 0.25%, the interest on $1,000 would come to a whopping $2.50, which is why for most working careerists, getting those annual filing notices from a commercial depositor bank is much more of a paperwork nuisance than anything that will change their annual filings substantially.
Still, there is a case to be made for early contributions. After all, according to that old cliche, "the early bird gets the worm" -- and that's not to mention the satisfaction of having contributions solidly in place before poring over 1099s, multipage depreciation forms, and everything else that starts to get very important prior to April 15.
So think about making the maximum contribution to IRA investments during the corresponding year or some time before the last minute. It could help in that complex equation of compounded interest that works for you as you age and provides you with something to live on when you retire.
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Justin Stoltzfus is a contributor to WiserAdvisor.