The Impact of an Annual IRA Contribution

IRA's and ROTH IRA's - Why it matters

IRA’s and ROTH IRA’s – Why it matters

Tax season is the perfect time to evaluate your financial plan, retirement preparation, and investment accounts.

Tax season is also an opportune time to make a commitment to implement a saving and investing plan.  Many times, an IRA is the easiest and most convenient option to begin saving and investing.

If you happen to be reading this during tax season, your accountant can advise you on how much you can contribute.  You should make a habit of asking your accountant the following questions:

  1. Am I (Are we) eligible for a ROTH IRA and/or an IRA contribution this year?
  2. If so, how much can I (we) contribute?

Your eligibility for either a ROTH IRA or a traditional IRA will be based on a number of factors, including age, income, and whether or not your employer offers a retirement plan. The maximum annual contribution that the IRS allows is $5,500 per year (or $6,500 if you are over age 50).

My Best Advice

If you are eligible for a ROTH or traditional IRA, my advice is to seriously consider making a contribution.

My experience has taught me that people often pass up the opportunity to make a $5,500 (or more) contribution to their IRA because they don’t believe it will materially impact their retirement plan.  It’s difficult to believe that a $5,500 annual contribution will ever amount to anything.  I think it’s this misguided belief that prevents people from saving in the first place.

While I agree that making the contribution for one year may not change your retirement age from 65 to 55, I do believe that an active commitment to consistent annual contributions can and more than likely will have a positive impact on your plan.

Saving, to use a childhood analogy, is the little engine that could – it thinks it can…it thinks it can!

What Is the Impact of $5,500 per Year?

The future value of saving $5,500 is going to depend on how you invest your money, and how the markets perform in the future.  While it’s impossible to precisely know what rate of return you will earn, we can project the value of your annual savings by using a sample of hypothetical rates of return.

As I mentioned above, saving $5,500 just once is not going to change your life.  If we assume that your investment earns a hypothetical 7.5% over 10, 20, and 30 years, we can calculate the future value of this money:

  • Value in 10 years – $11,335
  • Value in 20 years – $23,363
  • Value in 30 years – $48,152

(For illustrative purposes, at a hypothetical 5.5% your account value would be $9,393 in 10 years, $16,047 in 20 years, and $27,411 in 30 years).

By simply saving $5,500 a single time, it may be possible to have over $48,000 or more available for retirement.

It begs the question, what if you make a commitment to saving and contribute $5,500 each year for 10, 20, and 30 years to your IRA?  (Just to be clear, you can put less than the maximum allowable amount into an IRA each year, but it’s always good to set big goals, right?)

Assuming the same hypothetical 7.5% rate of return mentioned above, we can calculate the following values:

  • Value in 10 years – $77,808
  • Value in 20 years – $238,175
  • Value in 30 years – $568,696

(For illustrative purposes, at a hypothetical 5.5% your account value would be $70,817 in 10 years, $191,775 in 20 years, and $398,395 in 30 years).

As you can see from the numbers, an “insignificant” contribution of $5,500 per year into an IRA could have a substantial impact on one’s retirement plan.

What we can learn from this hypothetical example?

A few things actually:

  1. Saving is easy – Open an IRA and make a contribution.
  2. Saving matters – By making a contribution to your IRA each year, you may be able to substantially change your retirement situation.
  3. Get started early – the earlier you start, the larger your savings can potentially grow. Saving for 30 years could produce a total savings that is much higher than saving for 20 years.  The reason for this, of course, is compound interest (more on this coming soon).

Projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results.  A plan of regular investing does not assure a profit or protect against loss in a declining market.  You should consider your financial ability to continue your purchase through periods of fluctuating price levels. Withdrawals may be subject to federal income tax in the year they are withdrawn.  A penalty tax may be imposed for early withdrawals. None of the information in this document should be considered as tax advice.  You should consult your tax advisor for information concerning your individual situation.

Image courtesy of Stuart Miles at FreeDigitalPhotos.net 

 

, ,

No comments yet.

Leave a Reply