It was New Year’s Day and I woke up thirsty, headachy, trying not to think about the pile of dishes in the sink. My girlfriend and I held a New Years Eve party the night before, and we were both still recovering.
While she jumped in the shower, I ignored the dishes and flipped open my Mac between two sticky puddles of champagne drying on the living room table. I log into my Fidelity account and suddenly the headache’s gone. Hangover or no hangover, this is one of my favorite times of year…
New Years Day is special, but it’s not about taking a day off from work.
With each new year, a new window opens, and that window is the contribution you can make to your Roth or Traditional IRA. It’s pretty geeky, I know. But I like to geek out on personal finance. In fact, after years as a hobbyist, now I do it for a living.
It’s been a lifelong obsession of mine to minimize my investment fees and taxes and maximize my investments — legally, of course. … I don’t think they serve my favorite greek yogurt with fresh blueberries in Sing Sing.
So if you haven’t yet made your $5,500 contribution to your 2015 IRA, let’s keep going.
If you already maxed out your IRA for the tax years 2014 AND 2015, kudos. You’re in the minority. But even savvy investors may learn a few things here.
Just like you used to wait to begin your 7th grade social studies paper until the night before it was due, many folks wait until the April 15th deadline to make their IRA contribution. But it’s pretty simple why that’s not optimal. First, the earlier you invest, the more time your money has to grow. And if you have a Roth IRA, which I’m a HUGE fan of, especially for folks under 35, that money is growing tax free. Secondly, I’ve heard too many horror stories of people that “forgot” to make it by April 15th, or simply couldn’t get the electronic transfer processed in time. Remember, once that window closes, it is closed for good!
Let’s take a look at a very basic example of how much more money you may earn by investing early. It’s January 1st and you have $5,500 sitting in a savings account. That cash earns 0.75% in interest, the current market rate of a decent savings account, and by December 31st you’ve earned $41.39. You’ll get a 1099-INT form for that interest because you owe taxes on it. If you’re in the 25% tax bracket, you’ll owe roughly ten bucks in taxes, leaving you with a little over $30.
Or, here’s an alternative: Be a personal finance geek and make that IRA contribution with me on January 1st.
For the sake of comparison, let’s say you leave that in your IRA as cash (in reality, you want to put that contribution to work immediately, in a tax-efficient, well-diversified manner.) You still earn that same $41.39 in interest but this time you don’t get a 1099-INT, because that money is in a tax-sheltered account. If it’s a Roth IRA, you get to keep that entire $41.39 because you’ve already paid your taxes, and if it’s in a Traditional IRA, you’ll pay taxes when you take the money out in retirement.
While $41 per year may not sound like a lot, let’s see what the difference amounts to over 35 years. If you make your contribution at the beginning of the year as opposed to the end, assuming an 8% rate of return, you’ll finish with $74,582 more. Now THAT is a lot of money.
So whether you choose a Roth or Traditional IRA, make that contribution as early as you can! Flip open that computer when you’re watching the Rose Bowl, the Rose Parade, or while making your list of resolutions, and then tell your friends. You’ll be doing them a huge favor, and you’ll look smart, too. ;)
And if you don’t have the full $5,500 available on January 1st, set up automatic contributions. $5,500 divided by 12 is $458 per month. You can set up an automatic contribution from your checking account to your investment account each month, or better yet, send it directly from your employer’s payroll to your investment account. That way you’ll never be tempted to spend it. That’s called “paying yourself first.”
Just remember to invest the money once it hits your IRA so it’s not sitting in cash. If you use FutureAdvisor, we’ll invest it automatically for you, and balance the rest of your portfolio at the same time.
So next time you raise that champagne flute to a toast on New Years Eve, remember what you’re going to do the next day. Here’s to a healthy and wealthy 2015!
As always with IRA contributions, keep in mind:
- You need at least $5,500 in earned income to make the contribution.
- If you don’t yet know what your Modified Adjusted Gross Income (MAGI) will be for the year, be careful. IRA’s have eligibility limits ($114,000 MAGI for single filers and $181,000 MAGI for married couples filing jointly, in 2014. Those numbers went up slightly for 2015). If you earn above the limit, you may still be able to contribute using a “backdoor Roth.” Check with your tax professional if you have any questions.
- Treat IRA contributions as money you won’t need until age 59 ½.
The views expressed herein are not intended to serve as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell securities by FutureAdvisor. Differences in account size, timing of transactions and market conditions prevailing at the time of investment may lead to different results, and clients may lose money. Past performance is not indicative of future results. The tax efficiency discussed should not be interpreted as tax advice and it does not represent in any manner that the tax consequences detailed will be obtained. Clients should consult with their personal tax advisors regarding the tax consequences of investing.
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