Your Late IRA Contributions Have a Procrastination Penalty

If you had a choice between getting $100 or $80, which would you choose? The answer seems self-evident, but many investors are, in essence, opting for the lower figure when they procrastinate in making contributions to their IRA or other investment accounts.

There is a span of 15½ months in which you can make your annual contribution to an IRA, from January 1 of the applicable tax year through April 15 (the tax return deadline) the following year. While more investors are taking advantage of early contributions, Vanguard research found that many more are still holding their contributions until right before the deadline.

Throughout my career as a financial adviser, I’ve come across both early-bird contributors and “night owls” who wait until the last minute. The math usually points to better outcomes for the early birds, and here’s why.

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The penalty of procrastination

Imagine two investors, one contributing $7,000 to her IRA in January of every year, the second investor making his annual contribution 15 months later. Over 30 years, both would have contributed a total of $210,000, but the first investor would have a final balance that’s almost $42,000 higher, assuming 6% annual returns. For the second investor, that difference is a “procrastination penalty” that’s about 20% of his total contributions.

Of course, this is a hypothetical scenario only that does not represent any particular investment and the rate of return is not guaranteed; final results will vary considerably depending on market returns and your portfolio construction. But it illustrates that there is a heavy cost in delaying your contributions.

Making early and regular contributions easier

I rarely have to remind my older clients to make early contributions. Over the years, they’ve witnessed the power of compounding and the benefit of investing early and regularly. But they often relay that their adult children won’t follow the same practice, citing their busy daily lives, budgeting concerns or just plain forgetfulness.

For them — and for you if you face the same challenges — here are a few suggestions:

Automate your investment life. You can usually set up automatic investments on a weekly, monthly, quarterly or annual basis. Doing so removes all the hassles of remembering to make contributions. It has the added benefit of dollar-cost averaging — a fancy way of saying that, instead of investing in one lump sum, you invest a smaller fixed amount at regular intervals at different share prices. Dollar-cost averaging does not guarantee that your investments will make a profit, nor does it protect you against losses when stock or bond prices are falling, but it can help reduce, if not necessarily eliminate, the risk of loss through bad market timing.

Contribute a safe estimate now, the balance later. The previous suggestion may not be feasible for those with an unpredictable earned income stream, such as part-timers or freelancers. Instead, they may want to contribute a conservative amount now and then contribute the balance later once they have a firm idea of their reported income. However, I encourage consulting with a financial adviser to get a firm idea that their reported income will meet or exceed the amount of their contribution.

Don’t delay any investment transfers. Some may opt to contribute to a money market fund now within an IRA to make the deadline, then later transfer the money into asset classes that are more appropriate for their long-term financial goals. But don’t procrastinate on that transfer. While money market funds are providing more attractive returns recently, they are still no substitute for the higher returns that equities and bonds have provided historically over the long run.

Maximizing investments across the board

If you have more disposable income for savings, the following are also worth considering:

Frontloading your investments. While dollar-cost averaging lowers risks, Vanguard research indicates that, in most cases, investing in a lump sum early usually generates higher returns because of the extra time for compounding to take effect. If you’re contributing to your IRA for the 2023 tax year now, consider making contributions for 2024 at the same time. If you have an employer-sponsored retirement plan like a 401(k), you might consider increasing your payroll contributions, so you reach your maximum in the first few months rather than over the full year.

Don’t forget your other family members. Remember that you can contribute to your spouse’s IRA even if they don’t have earned income. If you have children who have earned income, also consider opening a Roth IRA for them. Limitations do apply.

Of course, all investing is subject to risk, including possible loss of the money you invest. But, as our examples illustrate, it usually pays to be the early bird. Invest early and regularly to avoid the procrastination penalty. And don’t forget, these principles can be applied to all aspects of investing for long-term success.

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