The start of a new year may not matter much from a resolution standpoint, but it does matter from an accounting and financial planning perspective. A new year presents new opportunity to maximize tax-advantaged space, make retirement contributions early, and consolidate your finances to a simpler state.
Here, we'll review three tax-smart moves to make the most of the new calendar.
1. Make IRA contributions early
As we've learned from the base principle of compound interest, the longer you hold an investment, the more interest it will generate in an exponential fashion. The same is true on a micro-level when it comes to making IRA contributions.
By making your traditional or Roth contribution as soon as the ball drops -- as opposed to every month in equal installments -- you're giving your money a chance to compound in tax-advantaged space for the longest amount of time. Since the stock market is more likely to go up than down on a given day, it follows that the sooner you invest your money, the better.
IRA contributions don't necessarily have to come from earned income, either. If you have the funds available, you can simply transfer the annual maximum from a taxable brokerage account to your IRA and be done with it for the year. If you're married, encourage your spouse to do the same.
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2. Contribute to a 529
If you have children, or even if you're expecting a child, 529 plans can offer tax advantages for the long-run expense of paying for higher education. Money in a 529 plan is tax-exempt if used for qualified educational expenses, which include college tuition and, more recently, apprenticeships. Annual, tax-exempt withdrawals are also available for payments of up to $10,000 to private K-12 programs.
Similar to the logic behind making your IRA contributions early, removing money from a taxable account and putting it into a 529 plan not only allows the money to compound for longer, but it also moves the money from a taxable space to a tax-advantaged (and possibly tax-exempt) space. Many states offer a further tax deduction of up to $10,000 for contributions to a state-sponsored plan, so you'll likely get a break on your state taxes if you live in a state that levies them.
Finally, if you're expecting a child, you can open a 529 plan in your own name (or your spouse's name) and then change the beneficiary of the account to your newborn when they're born (and when they have a Social Security number). This can be a clever way to front-load your 529 if you want to get a head start in advance of your child's birth while still keeping within the bounds of the law.
3. Front-load your 401(k)
Your company may allow you to make aggressive 401(k) contributions early in the year by simply filling out an online form. It does make sense in theory to fully fund your 401(k) as early on in the year as possible, as is the case with IRA contributions. Be aware that this can create a cash flow issue if you depend on your full paychecks to cover expenses, but early funding can be a smart way to get your retirement plan funded and growing faster.
The only caveat here is that some companies calculate their matching contribution based on how much you've contributed per quarter. If your company does this, it may not make sense to front-load your 401(k), because you may be giving up a substantial match. But if your company looks at your total annual contribution when it calculates its match, you might consider maxing out your 401(k) as soon as possible.
Make your best effort
Even if you don't max out all your retirement accounts in the same year, you should be applauded for making periodic contributions. Investing favors those who do it at all; there's no pressure to feel that you have to maximize every dollar that comes your way. Nonetheless, the sooner you start investing, the better your outcome is likely to be, and the more peace you'll experience when it comes to your finances.
