Thursday, December 10, 2015

Proactively Contributing to your IRA Can Earn You an Extra $75,000!

It is almost that time again; the year is coming to a close and you are wondering if you did everything you could throughout the year to help minimize your current or future tax liability. And then the panic sets in with all the talk about New Year’s resolutions, and you start wondering if you are doing enough to save and plan for your retirement.

If you have already contributed to your IRA for 2015, then you are already a step ahead of a lot of your peers. While you have until April 18, 2016 to make your 2015 contribution, we do not recommend waiting until the last possible day to make a contribution for your future. 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 2016 is January 4th).

As we all know, stocks do not rise in value in a straight line. Overall, the financial markets during 2015 have been pretty flat. The market was up nicely early in the year, then down during the summer and back to even this fall. Seasonally, the six months spanning from November to April have historically been the best performing months for the stock market. If you were to wait until April of the following year to make your contribution, you would risk missing out on what could potentially be significant appreciation in your retirement account.

Of course if we actually knew ahead of time the best day out of the 15 ½ month window to make your IRA contribution, we would obviously suggest you make it on the day when you can purchase additional investments at the cheapest price. Unfortunately, the daily gyrations of the market are terribly unpredictable.

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. In fact, 11 out of the past 12 years (including 2015 so far), the S&P 500 has produced positive returns. 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:

1. Our Expected Return for U.S. stocks is 8% annually (some years will be higher and some lower, but we will expect this average over the next 35 years).
2. Each Participant will make an annual lump sum contribution of $5,500 to their respective IRA.
3. Each person will retire at 65 (we will use this as the year-end age).
4. 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 will 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 is the moral of the story here? Be proactive – if you can, do not procrastinate making your annual IRA contributions. Make the most of your annual IRA contributions; do not 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 this update has been useful to you. Please feel free to email us and provide us with your thoughts and comments.

Best Regards,
Eddie Wilcox, CFA, CFP®

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