Happy new year!
Now that the holidays are over and all those new year’s resolutions have almost been broken (come on, admit it), here’s something you can do to help your long-term financial situation: make your IRA contribution now.
I’m not referring to prior year’s contributions (which you can make until April 15th of the current year); I’m talking about your 2017 contribution. It’s 2017 already – why wouldn’t you make 2017’s contribution as early as possible in 2017?
Most people are simply in the habit of waiting until spring of the following year to make their contribution, just before the deadline.
However, by making your IRA contributions as soon as possible, your investment will benefit from more than a full additional year of tax-deferred growth.
In a regular (non-retirement) investment account, your dollars compound over time, but taxes take regular, ongoing, small bites out of that overall growth. For example, if you buy a mutual fund outside of your IRA, it will likely create some activity that will be taxed, such as interest, dividends, or capital gains distributions. Additionally, if you sell that mutual fund at a gain, you will owe federal and state capital gains tax on any profit you’ve made. None of this is inherently bad – interest, dividends, distributions, and profit all mean that you’ve made money – but much of this activity is taxable, each year.
On the other hand, if you purchased the same mutual fund inside an IRA, all that activity can still take place – interest, dividends, distributions, and a profit from a sale – but none of it is taxed as it happens. The compounding effect of these funds, left untouched by taxes, can be mathematically impressive over the years (and is considered by most advisors to be the only “free lunch” in investing).
Therefore, one goal should be to move funds from a taxable environment (checking or savings account, traditional investment account) into a tax-deferred or tax-free environment (traditional or Roth retirement plan) as soon as possible.
Let’s look at two investors, both making ten IRA contributions, starting with contributions for 2017. Investor A makes her IRA contribution every January, as soon as she possibly can, starting in January 2017. Investor B makes her IRA contribution right before the deadline – so, April 2018, for her 2017 contribution. If they continue this way for ten years, Investor A will have 130 months (or almost 11 years) of additional tax-deferred growth (ten contributions, made approximately 13 months ahead of Investor B).
Of course, sometimes people have to save up in order to make contributions, or because of cash flow constraints can only contribute a certain amount to their IRA every month. But I’ve seen far too many cases where people have the funds available to invest, yet wait to contribute, year after year, until right before the April 15th deadline, for no particular reason other than they just haven’t bothered to do it.
The limit for both 2016 and 2017 contributions is $5,500 for those under 50, and $6,500 for those over 50. It’s still early in the new year. Make your (and your spouse’s!) IRA contribution – or as much of it as you can – now.