Statistics says 10,000 Americans reach retirement age every day.
Retirement is an exciting event for most people. If you haven't given your IRA much thought yet, now is the time to do so, regardless of the stage you're at in your career.
Read on to learn about funding your IRA and how to time contributions for maximum return on your investment.
What’s an IRA?
IRA stands for Individual Retirement Account and provides a way you can save money for your retirement. Almost everyone is eligible to open and fund an IRA.
The earlier you fund your IRA, the more opportunity you will have to build wealth to use towards your retirement. Depending on your strategy, you can also save on your taxes.
When to Start an IRA
There's no reason to delay setting up your IRA. You’ll hopefully retire at some point, so it makes sense to start planning for it as soon as you can.
However, there are a couple of things you should prioritize ahead of an IRA.
Before you start saving for retirement, you need to make sure you have savings you can access at short notice. This will keep you afloat if anything unexpected, like job loss or unplanned bills, should happen.
You should also pay outstanding short-term debts before making IRA contributions. Short-term debts, especially from credit cards, typically have high interest rates. This could cancel out any gains you get from IRA contributions.
Also, because of the favorable terms they offer to savers, you should max out your 401(k) offered through your employer before you start contributing to your IRA. If you don’t have access to a 401(k), then an IRA is a great alternative to start saving for your future.
How Much Can You Contribute to an IRA in a Given Year?
For 2020, you are entitled to contribute up to $6,000 subject to income limitations (this is the same as it was in 2019).
Should You Pay Into Your IRA All at Once or Across the Year?
You can make IRA contributions any time. Some people choose to make regular contributions to the account, while others prefer to deposit a lump sum once or twice a year.
The main advantage of a lump sum payment is that you can give your money more time to grow. If you max out your IRA contributions in the early months of the year, those funds have all that extra time to earn you interest.
The disadvantage of this approach is that it could leave you with liquidity problems if something unexpected happens later in the year. If you choose to make regular contributions, you can pause them if financial troubles happen.
Note that you can contribute to your IRA right up until the tax filing deadline for that year. For example, you can contribute to your 2020 IRA for all of 2020, and through April 15, 2021, which will be the deadline to file your 2020 taxes.
Consider Dollar Cost Averaging
Dollar cost averaging is an approach to investing that involves splitting up a large amount into smaller increments. This mitigates the risk of a significant market move, which could hurt the value of your investment.
The main advantage of this approach is that it removes the burden of analysis from the investor. If you decide to pay a certain amount into your IRA out of every paycheck, you won't have to make any decisions in relation to market value, opportunity cost, or other timing issues.
The main disadvantage is that you could potentially miss out on earnings if you buy too high.
Dollar cost averaging is an approach that’s popular among younger investors because few people, especially in the early years of employment, have money sitting around for a long-term investment plan.
When they break this amount down over regular periods, however, it becomes much easier to manage.
Keeping Your Retirement Fund Healthy From the Start
For younger workers, the idea of retirement can seem far away. However, preparing for it as early as possible is a good strategy because your money gets to grow much longer.
Keep in mind, there may be penalties if you withdraw your contributions before retirement age, as these accounts are intended to serve you in retirement. Learn more on the IRS website.
With this in mind, it's a good idea to pay as much into your IRA each year as you can afford. It will give you peace of mind down the road and will save you money on your taxes.
Whether you decide to contribute your funds all at once or throughout the year, you can’t go wrong because either way, you’re saving for your future. There are slight pros and cons for each method, but ultimately the most important thing is to get started as soon you can.