Tuesday, December 14, 2010

Q&A Series – Timing IRA Contributions

This week’s question comes from John, a client who is wondering when is the best time to contribute to his IRA – at the beginning of the year or at the end?

Q: When is the best time of year to make an IRA contribution?

The clear answer is “the sooner the better.” Many of you have received a note or an email in the past from Joe suggesting to make an IRA contribution early in the year. Undoubtedly, many wonder "what’s the rush?" You actually have until the tax filing deadline of the following year to actually make an IRA contribution, but it’s our position that it’s always in your best financial interest to make the contribution on January 1st or the first business day of each year (the first business day of 2011 is January 3rd).

Making the following assumption, here’s why contributing to your IRA on the first business day of the year is best:

  • Our expected return is 8% annually (keep in mind that some years will be better while others will not be as good, but we’ll expect this average over the next 35 years).
  • Each participant makes an annual lump sum contribution of $5,000 to his or her respective IRA.
  • Each participant will retire at 65.
  • We’ll assume this is the participants' only savings and not consider prior or additional investments.
If we make the assumptions noted above, you can see the results in the following table:

Age Year End Value (8% return - end of year contribution) Year End Value (8% return - beginning of year contribution) Difference
30 $940,506.84 $1,010,352.68 $69,845.84
40 $399,772.08 $431,753.84 $31,981.77
50 $151,621.42 $163,751.13 $12,129.71

Clearly, the savers who chose to invest their IRA contributions at the beginning of the year have come out much better. The 30-year old who contributes and invests for 35 years comes out nearly $70,000 ahead by making his or her contributions to gain the full benefit of each year’s returns. The 40-year old is better off by nearly $32,000, and finally, the 50-year old who has only invested for 15 years has over $12,000 more than if he or she had contributed at the end of the year instead.

What’s the moral of the story here? Be proactive; don’t procrastinate in making your annual IRA contributions if you can. There are very real and negative consequences to delaying your IRA contributions until the end of the year or waiting until the filing deadline in April.

John, I hope my answers above have given you a better understanding of our thoughts about when to contribute to your IRA each year.

We encourage our clients and readers to send us questions for our Q&A series at Contact@RollinsFinancial.com. And as always, we hope you will keep Rollins Financial in mind when seeking professional advice on financial planning and investing.

Best regards,
Eddie Wilcox

P.S. Some of you are probably good candidates to convert your regular IRAs into Roth IRAs before the end of the year, although we are almost out of time. If you’ve got severely diminished income in 2010 compared to future and past years, you’re probably a good candidate. Conversely, if you’re in the top bracket now and think you’ll be in the top bracket throughout retirement, you’re probably also a good candidate. Call us ASAP to discuss the details if you think your situation might apply.

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