Last year was the first year I have been able to make the maximum contribution to my Roth IRA, thanks in large part to becoming debt free. I was also able to fund a spousal IRA for my wife, who stays home with our kids.
Now that it is 2010 I am psyched to make even more contributions to our Roth, but wondered if I should wait until the end of the tax year, make monthly contributions, or try to plunk down all the money up front. Turns out this is a costly decision.
Putting aside thoughts on market timing, and market predictions for 2010, it seemed like socking away the maximum contribution early in the year was the way to go. Of course, this meant trying to come up with $5,000 after already depleting some savings to fund last year’s Roth.
Just as I was feeling nervous about moving another $5,000 from my cash reserves, I was reminded of my own advice: max out because Roth IRA withdrawal rules allow for withdrawal of contributions at any time without penalty. That’s right! Assuming I had not lost my entire investment in the Roth account, I could simply withdraw a portion of the $5,000 contribution later in the year in an emergency.
The Impact of Delaying Roth IRA Contributions One Year
So what’s the advantage of tying up my savings so early in the year? Using the financial calculators at Dinkytown.net, I ran a couple calculations with the following assumptions:
Let’s assume I turn 30 years-old On January 1, 2010, and according to the 2010 Roth IRA income limits I can invest the full $5,000 in a Roth IRA earning an 8% return. I continue to invest $5,000 on my birthday (January 1st) for the next 35 years. My original $175,000 in Roth IRA contributions would grow to $930,511.
If I delayed that first contribution until my 31st birthday, I’d only have $856,584. This is essentially the same result you’d get by waiting to contribute until the end of the year. And while it is nothing to sneeze at, you would lose about $74,000 in compounding growth by waiting a year to get started.
This certainly underscores the important of starting early. It also reinforces my plan to encourage our kids to open Roth IRAs as teenagers when they begin earning an income – even if we have to help them fund the account up to their income. Imagine what the numbers would look like if you started saving at 17 years old!
If you are concerned about earning too much money, contribute now and adjust later. It is possible to avoid penalties if you take corrective action by the due date for making Roth IRA contributions for that particular tax year (typically April 15th or the day you file your return, whichever occurs earlier, but not counting extensions, etc.).
I Have No Savings – Should I Borrow To Make Roth Contributions?
After being in debt for so long, I am very reluctant to borrow again. However, borrowing $5,000 at a very low interest rate (or even free if you can catch a zero-percent balance transfer) might make sense considering the amount of compounding growth you give up over an investing lifetime. Personally, I would not borrow the money, and look for another way to fund the contribution – a side hustle, selling something valuable, but not sentimental, etc.
Whatever you decide to do, do it quickly, as hundreds of dollars are sliding by for every day you put off funding a Roth IRA.