Friday, December 27, 2013

Timing IRA Contributions

This week’s blog is similar to one we ran as part of our Q&A series a few years ago. We often have clients who question our reasoning for making IRA contributions as early as possible, so I would just like to reiterate our stance.

In the past, many of you have received some form of communication from Rollins Financial suggesting you should make an IRA contribution early in the year. Many undoubtedly wonder, “What’s the rush?” Although you actually have until the tax filing deadline of the following year to make your IRA contribution, we find it to be in your best financial interest to make the contribution on the first business day of the year (which for 2014 is January 2nd).

As many of you know, stocks do not rise in value in a straight line. However, during 2012 and 2013 there was not a single day during either year that the S&P was negative in YTD performance. This means the best time to have invested was, in fact, day one! Granted this is an unusual situation, and if we actually knew ahead of time the best day out of the 15½ month window to make your IRA contribution, we would obviously suggest you make it on the day when investments are the cheapest. Unfortunately, no one can predict when that day will be. And if they could, they surely would not be reading this blog (or writing it for that matter).

That being said, let’s focus on the likeliest scenario. Stocks have produced positive annual returns in approximately 72% of the calendar year time periods since 1926. The probabilities suggest that there is value in contributing as early as possible. And here’s why….

As an example, let’s make the following assumptions:
  • Our Expected Return is 8% annually (some years will be higher and some lower, but we’ll expect this average over the next 35 years)
  • Each Participant will make an annual lump sum contribution of $5,500 to their respective IRA
  • Each person will retire at 65 (we’ll use this as the year end age)
  • This is their only means of savings
If we make the noted assumptions, you can see the results in the following table:

After reviewing the table, you’ll notice the savers, who choose to invest their IRA contributions at the beginning of the year and are exposed to the 8% return for the entire year, will realize higher returns. The 30 year old who contributes and invests for 35 years realizes total returns of over $75,000 more by making his/her contributions early in order 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 nearly $12,000 more than if he/she had waited and contributed at the end of the year.

I also performed the same test for those of you who can contribute to a SEP-IRA. Since SEP-IRA contribution limits are much higher, the potential benefits are also greater when making early contributions. Let’s start with the assumption that a 40 year old with 25 years until retirement can contribute $30,000/year annually to a SEP-IRA. This hypothetical investor could end up with an IRA balance at retirement containing an additional $175,000 in value by making his/her SEP contributions at the beginning of the year vs. waiting until the tax filing deadline to make the contribution.

What’s the moral of the story here? Be proactive! Make the most of your annual IRA contributions; don’t wait until the end of the year or until the filing deadline in April to make your contribution.

Thank you again for visiting and we hope you have found this information useful. Please feel free to email us and provide us with your thoughts and comments.

Best regards,
Eddie Wilcox, CFA, CFP®

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