Planning for retirement

Our top five IRA tips for 2022

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March 09, 2022
Planning for retirement
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Head of U.S. Wealth Planning Research

There’s no time like tax season to consider contributing to an IRA, according to Maria Bruno, head of U.S. wealth planning research at Vanguard. “While last year’s taxes are top of mind for most investors this time of year, it’s also an important time to think about your IRA contribution for this year,” she said.
 

Bruno recommends that investors consider these five steps when contributing to an IRA:

1) Contribute the maximum amount. For both the 2021 and 2022 tax years, investors under age 50 may invest up to $6,000 (or the lesser of your taxable compensation) in their traditional and Roth IRAs combined. Many Vanguard investors fail to invest the maximum, and over a 30-year savings horizon, this can mean lost savings in the tens of thousands of dollars. 2021 IRA contributions can be made until April 18, 2022.*
 

2) Take advantage of “catch-up” contribution opportunities. For the 2021 and 2022 tax years, IRA owners age 50 or older can make a catch-up contribution of up to $1,000 more, for a total maximum of $7,000 per person. So, a married couple who are both over 50 and eligible to contribute could make a combined contribution of $14,000.
 

3) Contribute sooner rather than later. Many investors, instead of making their IRA contributions at the start of a tax year, don’t make them until 15 months later, during the last two weeks before that tax year’s filing deadline. Investing early in the tax year means the compounding clock starts sooner, Bruno said. “Over the course of your working years, the procrastination ‘penalty’ can really add up,” she said. “So if you fall in this camp, see if you can make a change this year and make your 2022 IRA contribution now.”

Investors might consider making a double contribution. If they haven’t yet made a 2021 IRA contribution, they could make both their 2021 and 2022 contributions now. It might be surprising that the timing of IRA contributions matters, but the compounded effect of early contributions can make a significant difference over the long run.

Take the example of two investors who both contribute $6,000 a year to their IRAs. Investor A makes her contribution on January 1 of each year; Investor B does so on April 1 of the following year. Just by contributing earlier, Investor A could potentially end up with almost $17,000 more than Investor B, based on the hypothetical illustration below. 

Making IRA contributions early can be a beneficial strategy

Notes: This hypothetical example is for purposes of illustration only. All figures are in today’s dollars. The “early bird” investor contributes on January 1 of the tax year; the “last-minute” investor contributes on April 1 of the following year. This example assumes that each investor contributes $6,000 for 30 years and earns a 4% return annually after inflation. Projected balances are as of April of the ending year, when the last-minute investor makes the final contribution. This hypothetical example does not represent the return on any particular investment and the rate is not guaranteed.

Source: Vanguard.

4) Contribute a tax refund. Investors should consider using part or all of any tax refund to make an IRA contribution. For most people, a tax refund check is money they haven’t budgeted for. Because it’s essentially “found money” and not needed to pay bills or living expenses, it’s a relatively painless way to fund an IRA. The IRS even makes it easy by allowing taxpayers to have some or all of their tax refund sent directly to their IRA custodian. In fact, early filers this year can get their refunds and then make a contribution by April 18.
 

5) Don’t park the contribution in a money market account. We often see last-minute filers park their IRA contribution in a money market account until they can go back later to invest it. The problem is that many don’t go back. We recommend instead that you select a balanced fund or target-date fund for your IRA. The advantages of balanced funds are enduring—they’re low-cost, diversified, and professionally managed—and they provide for growth potential that a money market doesn’t, making them an appropriate long-term retirement investment.

These tips are simple and sound and can make tax season a little less daunting, Bruno said. “By following these five simple steps,” she said, “you can help put yourself on the right track for retirement—and maybe lower your tax bill as well.”

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* To qualify, the contribution must be made—or postmarked, if mailed—no later than the tax-filing deadline (without extensions). Remember to specifically designate it as a 2021 contribution; otherwise, it will be counted as a contribution in the year it is received (2022).

Nonworking spouses are also eligible to contribute as long as one spouse has earned income for the year and both spouses’ total IRA contributions don’t exceed the income reported on their joint return. Also, there is no income limit for nondeductible contributions to a traditional IRA. Although you don’t get to deduct those, the earnings grow tax-deferred until withdrawn.

If you’d like to contribute to a Roth IRA but you exceed the income limits, you may have some options. For instance, you could consider making a backdoor Roth IRA contribution (a contribute-and-convert strategy).

All investing is subject to risk, including the possible loss of the money you invest.

Diversification does not ensure a profit or protect against a loss.

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 its target date. An investment in target date funds is not guaranteed at any time, including on or after the target date.

When taking withdrawals from an IRA before age 59½, you may have to pay ordinary income tax plus a 10% federal penalty tax.

We recommend that you consult a tax or financial advisor about your individual situation.