Contribute to last year’s IRA before it is too late

Yes thats right, make a 2016 contribution to your IRA before April 15th.  The government allows catch up contributions for the previous year up until tax filing day in the US.  It is something a lot of people do not take advantage of but it can make a big difference over time if you miss out on this.

But why you ask? Simple answer…. Because once the date is gone, you will not be able to catch up on this year again. This is really important because the contributions are limited for an individual. This is one of the bullets you have in your gun to help you achieve your retirement goals and it can be a big mistake to skip this option. The impact over time can be huge. Time is a crucial element of successful investing and by skipping this you are ignoring the single biggest element for individuals to have success investing their hard earned money.

Scenarios

Let’s look at a of scenario where Not contributing comes back to hurt you:

Scenario:  You contributed $4500.00 to your IRA. You maxed out your 401(k) and you are on track to do the same this year. April comes around and you don’t take advantage of this. You have some extra cash due to a bonus you got from your day job. You decide to take a vacation or buy a new set of golf clubs you always wanted. Many years go by and this situation plays out again a few years where you just fell short of maxing out the IRA. Towards the end of your work career, realization sets in that you are still a little short for retirement. You only need about 50k more before calling it quits so you have to suck it up for another 1.5 years and head into work daily. You wish you had contributed more when you had the chance.

This is a fairly common situation for people trying to retire and achieve financial independence. You contributed the full 401(k), and you put another $4500 into the IRA. The thought is that wow, I have added a lot of money, it is time to enjoy life a bit. I don’t need to go overboard. To some extent I definitely agree with this line of thinking. Life is not punishment, what is the point of not enjoying yourself?  This has happened to me many times and I have been kicking myself for not going back and attempting to add more when I had the chance. The problem is, that you only get one chance to rectify this. The impact is pretty significant when you do some ‘back of napkin’ projections on this  (rough estimates and not intended to be absolute):

 

 

As you can see, even adding a catchup of $1000 has a big impact on portfolio value. That single contribution of a 3% yield dividend stock with an annual appreciation of 6% produces a 264% gain over a 15 year period. That totals $3,642.48 as an addition to your portfolio. Some may be thinking this is not significant but I disagree. This is a conservative estimate of 6% appreciation and a average yield of 3%. Upping the annual return value amplifies the return significantly ( I added 8% & 10% examples as well).   Additionally, this is for a one time $1,000 contribution.  I envision making larger or multiple catch up contributions over the years. It is not common for investors to max out their IRA and their 401(k). Personally, I dump buckets of cash at retirement and I still struggle to contribute every eligible dollar.  Lets take a quick look if we up this to a one time contribution of $3,000 …..

 

 

Wow !   That is incredible how much money a single $3,000 contribution can add up over the years. At 6% annual appreciation with the same 3% yield, we get the same 264.25% return for a total of $10,927.45. The 10% appreciation value is off the charts at over 18K !   This is the kind of real money that can make a huge difference in a retirees portfolio. I can imagine that adding this every couple of years could reduce the time to retirement by a year or two and provide an extra buffer of security for individuals. It is even possible that a married couple could both catch up and super charge their nest egg. That would be awesome. I look at these numbers and it reinforces the notion that retirement is very achievable with a little discipline.  It makes me want to find more ways to max out the contribution every year. I do not want to miss out on all the compounding and price appreciation that I have the potential to earn over a few years.

Conclusion – IRA Contributions

It is not easy to max out your contributions every year, so take advantage of the time before tax filing to catch up on any gaps in your yearly IRA contributions.  No one knows what will happen this year or next. You never know, you may come into some unexpected money after the April deadline and kick yourself for not maxing out the previous year. I would rather take away from this year’s contribution and add to last year’s just in case I hit the lottery or inherit some unexpected cash. Maybe I get a promotion and a fat raise. You just never know and you have the rest of the year to try and make up the current year’s $5,500 contribution. Remember, it is never too late to start ( see Retirement Savings …). The prudent move is to max out the previous year and then focus on catching up. The goal would be to be in a good position to be able to max out during the current year but if you can’t,  plan ahead and have the foresight to reap the benefits of adding every available dollar. Good luck !

 

-Brian