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Does It Really Matter When I Contribute to My Retirement Accounts?

By Kailey Hagen - Dec 9, 2020 at 6:20AM

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Spoiler alert: Yes, if you want to make the most money possible.

What if I told you you could increase your retirement balance just by making your contribution at the right time? Or that making a contribution at the wrong time could lead to problems with the IRS? Both are true. If you want to end up with the largest nest egg possible, knowing when to contribute to your retirement account is almost as important as contributing in the first place. 

Below, we'll look at how the government deadlines for retirement contributions and the frequency of your contributions can affect your tax bill and your portfolio.

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Deadlines for contributing to retirement accounts

You must make your 401(k) contributions by Dec. 31, 2020 if you want them to write them off on this year's taxes. Do this by logging into your online 401(k) account or talking with your company's HR department to change your deferral percentage. This will change the amount of money your employer withholds from each paycheck and places in your 401(k) on your behalf. You usually cannot make lump-sum contributions to your 401(k).

If you're interested in making an IRA or health savings account (HSA) contribution, you may do so up until the tax filing deadline. For the 2020 tax year, that's April 15, 2021. But making a contribution in 2021 for 2020 is a little more complicated and involves a little more care than you'd need if you simply got your contribution done and in by Dec. 31.

First, you must make sure your plan administrator applies your contribution to the correct year. They often default to the current year, so if you'd like to make a prior-year contribution, you may have to specify that. Follow up and make sure it's done correctly, or the IRS could think you're trying to cheat it when you try to write off your late contribution on your 2020 taxes.

You should also try to make your contribution before you file your taxes. You technically have until April 15, 2021 to make an IRA or HSA contribution, but if you file your taxes in March and decide to make a prior-year IRA contribution in April, you'll have to submit an amended tax return to claim your tax deduction.

Remember, you're only allowed to contribute up to $6,000 to an IRA in 2020 and 2021, or $7,000 if you're 50 or older. The limits for 401(k)s are $19,500 and $26,000, respectively. Exceeding these limits results in penalties, so keep them in mind when deciding which year you'd like to make a contribution for. If you're already over the above limits, you're better off waiting until you can make a 2021 contribution. 

The advantages of monthly retirement contributions

You'll have a blank slate in 2021, and you must decide not only how much you're going to contribute to your retirement accounts but also when you're going to make your contributions. Some people prefer to wait until the end of the year and make a lump-sum contribution with whatever money they've managed to save. But it's often smarter to make regular monthly contributions instead.

Doing this gets you in the habit of saving money for retirement and ensures you can make a substantial contribution. You might have every intention of putting money away for retirement at the end of the year, but if you're not routinely setting aside funds for that purpose, there's a chance you could accidentally spend it.

Another reason for making monthly contributions is that you're giving some of your savings more time to grow. Let's say you wanted to put $5,000 in your IRA. If you did so at the end of December 2021, your end-of-year balance would be $5,000. But if you broke that $5,000 into about $417 per month, your January contribution could grow to be $446 by the end of the year if you earned a 7% rate of return. Likewise, your contributions from all the other months may have generated some investment earnings as well, making your end-of-year balance higher than the $5,000 you personally contributed.

If you are going to make a lump-sum contribution, it makes more sense to do so at the beginning of the year, assuming you can afford it. Then, you're giving your entire contribution additional time to grow. If you contributed the $5,000 from our example above all at once on Jan. 1, 2021 and it earned a 7% rate of return that year, it'd be worth $5,350 by Jan. 1, 2022. 

But in challenging times like these, you also have to weigh your financial security. Though the government waived them for 2020, there are penalties for withdrawing your retirement savings before age 59 1/2, so it's better to hold onto your cash if you think you may need it to cover your living expenses in 2021 than to lock it up in a retirement account. It's ultimately up to you to weigh all of these factors and decide when makes the most sense for you to contribute to your retirement accounts.

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