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.