Are you maximizing your contributions across all of your retirement accounts? When do you make them? Vanguard research shows that more investors are taking advantage of early IRA contributions, but there are still quite a few who potentially pay the price for procrastinating.
Tips for maximizing your IRA
Read time: 3 minutes
You can save for your retirement in multiple ways. Contributing to your employer’s retirement plan is a wise first step and the primary retirement savings strategy for many investors. But you can also save money in an IRA, or an individual retirement account. This is a personal, tax-advantaged account that investors can also use to prepare for retirement. Here are some tips gathered from insights into Vanguard investors’ contribution behavior in recent years that show why contributing to your IRA earlier is a good practice.
1. Contribute early to take advantage of compounding.
Although we’ve seen an increased trend of “early-bird” IRA contributors (shown in the first graph below), there’s still a significant percentage of investors who wait until the next year to contribute. Many even hold off until April. Waiting can result in potentially paying a steep procrastination penalty by missing out on the power of compounding. As you can see in the second graph, that simple contribution timing decision can make a significant difference!
Investors shift timing of IRA contributions
The power of compounding
This example is based on an investor making a one-time, lump-sum contribution of $6,500 in January of the current year (early) and realizing a 6% return versus a one-time, lump-sum contribution of $6,500 in April of the following year (late) and realizing a 6% return.
Note: This is an example only. It doesn’t represent a real investment, and the rate of return is not guaranteed.
Source: Vanguard
Note: This is an example only. It doesn’t represent a real investment, and the rate of return is not guaranteed.
Source: Vanguard
2. Set up automatic contributions to benefit from tax-advantaged growth.
If you’re not able to contribute a lump sum early in the year, you can still participate in the tax-advantaged growth by contributing through an automatic contribution program during the year. For example, if you want to get to that $6,500 maximum for the 2023 tax year, consider establishing a $542 monthly contribution.
Investors who are age 50 or older can contribute even more—up to $7,500 annually—making this monthly contribution $625. We recommend that you consult a tax or financial advisor about your individual situation.
Investors who are age 50 or older can contribute even more—up to $7,500 annually—making this monthly contribution $625. We recommend that you consult a tax or financial advisor about your individual situation.
3. Pair contribution and investment decisions so contributions aren’t parked in cash.
Some investors seem to be focused on the act of making their contribution but forget to invest it—like it’s a check-the-box exercise. By separating the contribution and investment decisions, they can end up leaving money sitting in cash for months before they invest it, so they miss out on the potential returns that could have been earned.
To avoid paying the potential opportunity cost of being uninvested, it may make sense to consider investing right away in either a target-date fund or a balanced fund, especially if you have several years until retirement. If you’re closer to retirement, a more income-oriented investment might be your choice. You can also benefit from dollar cost averaging—which is investing a fixed dollar amount on a regular basis. Dollar cost averaging seeks to provide a hedge against market fluctuations.
To avoid paying the potential opportunity cost of being uninvested, it may make sense to consider investing right away in either a target-date fund or a balanced fund, especially if you have several years until retirement. If you’re closer to retirement, a more income-oriented investment might be your choice. You can also benefit from dollar cost averaging—which is investing a fixed dollar amount on a regular basis. Dollar cost averaging seeks to provide a hedge against market fluctuations.
Start saving more today
Now that you’ve saved in your employer’s retirement plan, consider saving in an IRA. There can be benefits and increased flexibility from investing in multiple retirement accounts. And by contributing to an IRA earlier in the year, you can give your money more time to grow. You’d also have more time to make your IRA investment decisions so you can avoid leaving your money in cash. Get a jump on your investing goals for the year and make your contributions today.
Whenever you invest, there's a chance you could lose the money.
Target-date investments are subject to the risks of their underlying funds. The year in the investment's name refers to the approximate year (the target date) when an investor would retire and leave the workforce. The investment will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. A target-date investment is not guaranteed at any time, including on or after the target date.
Neither Vanguard nor its financial advisors provide tax and/or legal advice. This information is general and educational in nature and should not be considered tax and/or legal advice.
Neither Vanguard nor its financial advisors provide tax and/or legal advice. This information is general and educational in nature and should not be considered tax and/or legal advice.