Retirement and financial planning are all about being as efficient as possible with our money. There are many aspects involved such as taxes, investment returns, budgeting, and so on, but the bottom line is efficiency. I have found that our road to efficiency is often blocked by something called procrastination.
One way procrastination hurts us is the timing of our Roth IRA contributions. Roth IRAs are a common retirement savings tool, especially for younger generations. The timing of Roth IRA contributions can be a big factor in retirement savings.
If you are here for the cliff notes version, here is the take away: If you make your Roth IRA contributions at the beginning of the year, you can make significantly more money than if you were to wait until the tax deadline.
There are two common ways to contribute to a Roth IRA:
- Systematic monthly contributions
- Lump sum
The systematic contributions are typically withdrawn from a checking account and invested every month. This method may be the best for a lot of people because it is automatic – you never have to remember to write a check.
For individuals that contribute a lump sum to their Roth IRAs, I have a question for you – when do you make that lump sum contribution? The most common answer is March or April of the following year, or before the April 15th tax deadline. For example, in April 2017, you wrote a check for your 2016 contribution.
There isn’t anything wrong with this method until you look at what could happen if you contribute earlier.
Make an Extra 90k
The maximum contribution to a Roth IRA for 2017 is $5,500. What if you made that contribution at the beginning of the year instead of waiting until April of next year?
If we take an example of a 35 year old that plans on retiring at the age of 65, he will have 30 years of contributions to his Roth IRA. By contributing at the beginning of the year, he will have $5,500 invested for 30 years that he wouldn’t have if he were making his contributions right before the tax deadline. He may still contribute the same amount over a 30 year time period, but he won’t have anything invested immediately, and his last contribution will be after he retires.
If that $5,500 that was immediately invested returns 10% over the 30 year time period, he will make over $90,000 just by making early contributions. He still contributes the same amount, but he will end up with significantly more money in retirement just by altering the timing of his Roth contributions.
Does the same hold true with a 45 year old, or 55 year old? Sure it does, the numbers just aren’t going to be as big because the time period will be shorter. When it comes to investing, the time value of money is a big factor.
Again, financial planning really comes down to being as efficient as possible with our finances. There are many little things we can do, such as contribute to Roth IRAs at the beginning of the year, to improve our financial situation. If you would like to have a discussion about our financial planning process and how we can help, you can email me here, or schedule a 15 minute phone call here.
Brad Bobb, CFP® is the owner of Bobb Financial Inc, and an expert in retirement planning for federal employees.