We love the IRA:
No, not that IRA!
One of the coolest things about IRAs is they provide two financial wins in one snappy acronym:
- Growing your money
- Shrinking your taxes
Various IRAs have different contribution limits, but no matter which one you choose, if it’s feasible you should make every effort to max it out. Here’s why (and how):
Time Is Your Biggest Cash Bonus
The sooner you invest, the sooner your money can earn returns. The sooner those returns can start earning more returns. This process of compounding returns means that the earlier you invest, the more powerful your money becomes. In this sense, the sooner you max out your IRA, the more your money can blossom.
However, the later you max out your IRA, the fewer returns you have the potential to earn – even if you’re contributing the same amount of money!
Don’t Wait for the End (Or Beginning) of the Tax Year
If investing sooner can lead to higher compound returns, why do so many of us wait until April (or May) to contribute to our IRAs?
It may be that we forget about our IRAs until tax season or delay because we don’t have the full amount to deposit right now. The easiest way to overcome both is to max out your IRA every week or month as opposed to every year.
Contributing small amounts regularly introduces a new investment strategy to your financial plan: dollar-cost averaging. You always want to be able to buy when the market is low, because that’s when assets are essentially “on sale.” But you never know if the market is going to go up or down. If you invest your yearly contribution all at once, you’re making an unfounded bet the stock market is going to be very low that day, when it could just as likely be pretty high.
Alternatively, dollar-cost averaging invests small amounts regularly to decrease the chance of only investing when the market is high. This helps “average” out the “dollar cost” as you purchase your investments. Sometimes you’ll invest when the market is high, but you’ll also catch the low days – AKA the days the market is on sale.
The best way to hold yourself accountable for depositing consistently is through setting up auto-deposit. Determine what your max yearly contribution is, then divide it by 12 and deposit that amount every month. For example, if you want to max out your individual Roth IRA by setting up a monthly auto-deposit, then divide $5,500/12, and set your auto-deposit to $458 monthly.
Save Money On Taxes
Okay, so if investing is all about doing it sooner, why should you go with IRAs over other types of accounts?
What makes maxing out an IRA different than contributing to your personal investment account are the tax benefits. Roth, Traditional, and SEP-IRAs each have different tax considerations, but they all have one thing in common: tax benefits.
With a Roth IRA, you have already paid taxes on the money you contribute upfront, but you don’t have to pay taxes on the money post-withdrawal. So the returns you earn are withdrawn tax-free.
With a Traditional IRA, you can receive a tax deduction on your contributions (thereby making your contributions “pre-tax”), but you’ll pay taxes on the money post-withdrawal.
A SEP-IRA is a type of Traditional IRA and has the same tax policy, although it has different contribution limits.
The best way to earn as much tax-exempt or tax-deferred income as possible is by maxing out your IRA.
Learn more about the different types of retirement plans here.
Bottom Line, Max Out Your IRA
Your IRA not only grows your money, but hands that growth over to you tax-free. Don’t worry about spending too much time with your IRA – it wants to be maxed out (monthly)!