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Planning for retirement

3 ways to maximize your IRA contributions

Vanguard research shows a trend toward investors contributing earlier to their IRA, but many are still paying a steep procrastination penalty.
4 minute read
April 03, 2023
Planning for retirement
Roth IRAs
Traditional IRAs
Retirement contributions

Did you know you can contribute to your IRA up to 15 months before the tax-filing deadline? Vanguard research shows that more investors are taking advantage of early contributions, but there are still quite a few who potentially pay the price for procrastinating.   

As you work to complete your 2022 taxes, it’s the perfect time to get a jumpstart on the 2023—contribute to your IRA now instead of waiting until next year. Here are some tips gathered from insights into Vanguard investors’ contribution behavior over the past several years that show why this is a good practice:

1.     Contribute early to take advantage of compounding.

Although we’ve seen an increased trend of “early-bird” contributors (shown in the first graph below), there’s still a significant percentage of investors who wait until the next year to contribute. Many even hold off until April. Waiting can result in potentially paying a steep procrastination penalty by missing out on the power of compounding. As you can see in the second graph, that simple contribution timing decision can make a significant difference!

Investors shift timing of IRA contributions

Note: Between 2019 and 2021 there was an approximate 7% increase in investors contributing to their IRAs in January of the current year, and about a 9% decrease in investors contributing in April of the next year.

Source: Vanguard.

Early contributors get the compounding 

This example is based on an investor making a one-time, lump-sum contribution of $6,500 in January of the current year (early) and realizing a 6% return versus a one-time, lump-sum contribution of $6,500 in April the following year (late) realizing a 6% return.

Note: This hypothetical example doesn’t represent the return on any particular investment and the rate isn’t guaranteed. 

Source: Vanguard.

2.     Set up automatic contributions to benefit from tax-advantaged growth.

If you’re not able to contribute a lump sum early in the year, you can still participate in the tax-advantaged growth by contributing during the year through an automatic contribution program. For example, if you want to get to that $6,500 maximum for the 2023 tax year, consider establishing a $542 monthly contribution.

3.     Avoid decoupling contribution and investment decisions so contributions aren’t parked in cash.

Some investors seem to be focused on the act of getting their contribution in rather than making sure it’s invested; like it’s a check-the-box exercise. By decoupling the contribution and investment decisions they can end up leaving money sitting in cash for months before they invest it, thereby missing out on the potential returns that could have been generated. To avoid paying the potential opportunity cost of being uninvested, make sure to take that extra step when you contribute and consider investing right away in either a target date fund or balanced fund.

Get a jumpstart on next year

So, as you’re wrapping up your 2022 tax returns, which are due on April 18, 2023, take some time to get ahead of next year by making and investing your IRA contribution now.

Take advantage of early contributions now

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Investments in target date funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the work force. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on the target date. An investment in target date fund is not guaranteed at any time, including on or after the target date.

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