When do you contribute to your IRA?
When we were getting started, we were contributing up to the last possible day because that’s all we could do. Couldn’t even max out, but it was something. Then, we shifted to regular contributions throughout the year. I’ve since come across some compelling arguments for maxing out your IRA in a lump sum as soon as possible in the tax year.
If you have the extra money and you’re intending to invest it at some point, consider whether doing it ASAP makes sense.
You have several options for when to make your IRA contributions.
- You could send the maximum ($5,500 for those under age 50; $6,500 for those age 50+) on the first day of business in the eligible calendar year, so January 3, 2017 for 2017 contributions.
- You could make even, regular contributions throughout the year. One way might be twice monthly, so $5,500/24 = $229.16. Or, spreading it out even more and taking 15.5 months or so to do it from January – April (a 15.5 month span). $5,500/31 = $177. This approach is dollar-cost averaging. If you don’t yet have the funds, but will at each paycheck to make a contribution, this option makes the most sense.
- You could make deposits any other number of times, perhaps when you have a tax refund or a quarterly bonus.
- You could send the maximum $5,500 on the last eligible day of the tax year, which is Tuesday, April 17, 2018 for 2017 contributions.
Is there a best approach? Well, the best is doing it, period, even if it isn’t optimal timing. Do what you can with what you have.
But if you’re already sitting on $5,500 in your savings account and it is earmarked for your IRA anyway, models suggest it is best to invest it in full right away. The reason? The full amount is invested for the longest possible period, a full 15 months more than if you invested it all on the last possible day. It’s 15 months more of potential growth and dividends. Over time, the impact can be substantial. It even usually beats dollar-cost averaging throughout the year.
Betterment ran a model on early IRA contributions vs later using data from the last 100 years, and saw over a 10-year span, the impact of contributing the max on the first possible day resulted in a $14,504 average increase. And that’s just 10 years! Go look at that fascinating article and graphs. Some 10-year spans were particularly booming, with $40k more in accounts by investing on Jan. 1 than 15 months later. Seriously?!
There were some down years and I bet you won’t be surprised to hear they were during the Great Depression and again in the recession of 2008. C’est la vie.
Coming in 2nd place: making regular contributions throughout the year. Still a solid option if you can’t max it out as soon as possible.
For more, see:
Another article on Betterment, Early Birds Get More Returns
Dollar Cost Averaging Just Means Taking Risk Later, a report by Vanguard (pdf )
Is Dollar Cost Averaging the Cure for Market Jitters? an analysis by ABGlobal. They found that 20% of the time, DCA won out over lump sum investing in very poor markets. The other 80% of the time, both DCA and holding cash hurt, with varying degrees. Isn’t it interesting to think “doing nothing” and holding cash can actually be the worst choice in some situations?
As for me, my husband and I have maxed out our IRAs for 2016, but we didn’t do it until early 2017. Due to some cash-flow issues at his work, we stopped our regular IRA contributions for awhile for the sake of hoarding cash. It was a borderline emergency with him uh, not getting paid for awhile (don’t get me started). We had to think for the short-term and I’m good with that choice.
Now that the work situation is turning around, we’re back to investing at Vanguard (love their low fees and index funds!). If the rest of January goes as expected, I plan to fully fund both IRAs for 2017 by the end of the month. The same goes for our strategy for our kids’ 529s. They’re now getting a lump contribution in January and more will follow in one-off situations (a portion from bonuses or gifts or whatnot).
401(k) or other employer-sponsored retirement
If your employer offers a retirement plan and has a match, the mathematically better solution is to make even, regular contributions throughout the year so to capture the greatest employer match. If you did the full $18,000 in oh, the first 3 months of the year (you high-roller, you!) it is likely that your employer would only do the match for your salary for those 3 months, rather than your full 12-month salary. I’m of the persuasion that it makes more sense to get the entire employer match in this case. Check with your HR department.
No match? Well, getting it done ASAP makes sense then for the same reasons as the IRA.
P.S. — thank you to Jayme who reached out to me on Facebook to discuss some different possibilities regarding retirement investments! I’m always delighted to chat with anyone about personal finance.