Sure, you have until the end of next year’s tax filing season to make contributions to your IRA that will go toward this year’s taxes, but some financial experts believe there is a compelling reason to fund your account as soon as possible in the calendar year: the potential for higher returns.
Indeed, by contributing to your IRA in January (or at least during the first few months of the year) rather than waiting until the following year’s tax-filing deadline, you are effectively providing that money up to 15 extra months of tax-deferred, compounded growth. This has the potential to add up over time.
Assume you put $6,000 into your IRA at the start of the year (the combined total amount taxpayers under 50 are allowed to contribute to a regular or Roth IRA as of 2020). In an email conversation, Leslie Beck, owner and principal of Compass Wealth Management in Rutherford, New Jersey, estimated that you will have amassed nearly $700,000 by the time you retire, assuming a moderate 5% annual return. With all else being equal, if you had made those identical contributions at the end of the year instead, you would have accumulated nearly $33,000 less.
Catch-up contributions to an IRA allow those 50 and older to contribute an extra $1,000 per year, increasing the potential for tax-deferred growth even more.
“It’s kind of insane that individuals wait until the next year’s filing deadline to make their IRA contributions,” Beck said. “They should do it at the beginning of the year,” she says, “but I think people wait because that’s when they do their taxes, so they psychologically bundle it all in together.”
Each year, the IRS allows taxpayers to contribute to their IRA up until the tax-filing deadline of the year in which the contribution is made. That is, you can contribute to your 2020 IRA at any point between January 1, 2020, and the deadline for submitting your taxes.
Whether or not you join in a company-sponsored retirement plan, such as a 401(k), you can contribute to a traditional or Roth IRA (k).
1 If you or your spouse are covered by a company retirement plan and your income exceeds certain thresholds, you may not be able to deduct all of your conventional IRA contributions. For the 2020 tax year, single taxpayers with a modified adjusted gross income (MAGI) of more than $65,000 and married joint filers with a MAGI of more than $104,000 will see the deduction phase out. For single filers with a MAGI of $75,000 or more, and married joint filers with a MAGI of $124,000 or more, the ability to deduct IRA contributions is fully lost.
According to the IRS, the ability to contribute to a Roth IRA begins to phase out in 2020 for single taxpayers with MAGI of $124,000 or more, and for married taxpayers filing jointly with MAGI of $196,000 or more.
As a result, persons with fluctuating income or income close to the Roth phase out limits may need to wait until the end of the year to see if they qualify to contribute, according to Beck.
If you, like most taxpayers, wait until the tax-filing deadline to make a prior-year contribution to your IRA, you’ll need to be financially prepared if you want to start making current-year contributions in January.
Not only must you contribute to your 2020 IRA before the tax filing deadline ($6,000), but you must also contribute to your 2021 IRA as soon as feasible (another $6,000, since the ceiling remains the same).
It costs $12,000 for an individual and $24,000 for a married couple. (Calculator: What should I put aside for retirement?)
Not everyone, especially after the holidays, has that much additional cash on hand. The good news is that it only happens once a year, during the changeover year. Following that, you’ll make a single current-year contribution in January of every calendar year.
Your tax return, if you expect one, and any year-end bonus you may receive from your company are two potential cash sources for those who choose to make prior-year and current-year IRA contributions in the same year.
According to Beck, you may be able to use your personal savings as long as you don’t use your emergency fund, which is required to ensure that you can continue to pay your payments in the case of an unexpected layoff, illness, or unplanned expense. Most financial experts advise saving three to six months’ worth of living expenses in a liquid, interest-bearing account, but those with job or income insecurity may need to save up to a year’s worth of living expenses. (See also: How to Create an Emergency Fund)
If you can’t come up with the money to make a current-year IRA contribution on top of your prior-year contribution, Beck recommends funding your 2020 IRA as usual by the tax filing deadline (normally in April) and opening a separate savings account now to start saving for a double contribution (2021 and 2022) in early 2022.
“If coming up with a lump-sum contribution is an issue,” Beck said, “saving monthly for next year is certainly another way to achieve it,” adding that those deposits should be kept separate from your regular checking or savings account because comingled money tends to get spent.”
If you’re already on track to fully fund your 2020 IRA this spring, you’ll need to save $500 per month this year to reach your goal of $6,000 by January 2022.
Despite the potential benefits of putting your retirement money to work sooner, because many IRA investments are linked to market performance, there are some potential drawbacks to consider.
The risk of market timing is first and foremost, according to Bill Brancaccio, a financial advisor and founder of Rightirement Wealth Partners in White Plains, New York.
He claims that investing a big sum ($12,000 for individuals, $24,000 for couples) in the market at any time makes your investment more exposed to market movements. “What if you put all of your money into the account on January 1st, and the market drops that year?” Brancaccio was the one who inquired. “You could have done better if you had invested $450 every month.”
Dollar-cost averaging is suggested for most retirees, he said. This is an investment technique in which you invest a modest, predetermined sum at regular periods into mutual funds or retirement accounts, spreading out your stock purchases over time. That way, you won’t be forced to acquire all of your shares at the same time while they’re trading at their highest price. (See Understanding Dollar-Cost Averaging for further information.)
David Demming, founder and president of Demming Financial Services Corp. in Aurora, Ohio, agreed that developing a saving habit is more important than making IRA contributions for long-term financial success. He recommends that most clients set up recurring monthly investments in their IRA to help balance out portfolio volatility.
In an email interview, he remarked, “Time value of money is significant, but paying yourself first is more vital.” “We dollar-cost average, which means we set up automatic monthly donations from most qualified Rothers’ bank accounts.”
Investors “learn the habit of saving systematically” by contributing to their retirement account on a monthly basis, he said.
Opinions, on the other hand, differ. Retirement savers who have the funds and are eligible to participate, according to Scot Hanson of EFS Advisors in Cambridge, Minnesota, should take advantage of the potential for extended tax-deferred growth.
“I urge all my clients to fund their Roth IRAs in January of each year if they can comfortably write the check and anticipate to be eligible,” he added, emphasizing that the sooner you contribute, the sooner your money may start working for you.
As always, consult with your financial advisor to see if an early IRA contribution is appropriate for you.
When can I contribute to a Roth IRA for 2020?
You have until the next year’s filing date to contribute to an IRA. You have until April 15, 2021 to contribute for the 2020 tax year if you filed your taxes in 2020.
What is the deadline to contribute to a Roth IRA for 2021?
Limits on contributions If you’re still working, evaluate the 2021 IRA contribution and deduction limits to ensure you’re getting the most out of your retirement savings. You have until April 15, 2022 to make IRA contributions for the year 2021.
Can I make a Roth IRA contribution for 2020 in 2021?
You may contribute to both a Traditional and a Roth IRA at the same time (subject to eligibility) as long as the total amount contributed to all (Traditional and/or Roth) IRAs does not exceed $6,000 ($7,000 for those 50 and older) for tax year 2020 and $6,000 ($7,000 for those 50 and older) for tax year 2021.
Can I put money into a Roth IRA anytime?
You can start a Roth IRA at any age as long as you have a source of income (you can’t contribute more than your source of income). There are no mandatory minimum distributions.
Can I have multiple Roth IRAs?
You can have numerous traditional and Roth IRAs, but your total cash contributions must not exceed the annual maximum, and the IRS may limit your investment selections.
What happens if I contribute too much to my Roth IRA?
If you donate more than the standard or Roth IRA contribution limits, you will be charged a 6% excise tax on the excess amount for each year it remains in the IRA. For each year that the excess money remains in the IRA, the IRS assesses a 6% tax penalty.
What is the downside of a Roth IRA?
- Roth IRAs provide a number of advantages, such as tax-free growth, tax-free withdrawals in retirement, and no required minimum distributions, but they also have disadvantages.
- One significant disadvantage is that Roth IRA contributions are made after-tax dollars, so there is no tax deduction in the year of the contribution.
- Another disadvantage is that account earnings cannot be withdrawn until at least five years have passed since the initial contribution.
- If you’re in your late forties or fifties, this five-year rule may make Roths less appealing.
- Tax-free distributions from Roth IRAs may not be beneficial if you are in a lower income tax bracket when you retire.
Do I have until April 15 to do a Roth conversion?
The Roth IRA conversion deadline (December 31) and the IRA contribution deadline (March 31) are two major annual deadlines (the due date for filing taxes, around April 15 of the next year with no provision for extensions).
How much should I put in my Roth IRA monthly?
The IRS has set a limit of $6,000 for regular and Roth IRA contributions (or a combination of both) beginning of 2021. To put it another way, that’s $500 every month that you can donate all year. The IRS permits you to contribute up to $7,000 each year (about $584 per month) if you’re 50 or older.
Can I open a Roth IRA if I make over 200k?
Contributions to Roth IRAs are not allowed for high-income earners. Contributions are also prohibited if you file as a single person or as the head of a family with an annual income of $144,000 or over in 2022, up from $140,000 in 2021. The income cap for married couples filing jointly is $214,000, up from $208,000 in 2021.
As a result, a backdoor Roth IRA provides a workaround: employees can contribute to a nondeductible traditional IRA before converting it to a Roth IRA. The identical conversion strategy is used in a giant backdoor Roth IRA, but the tax burden on the conversion could be greatly reduced or eliminated.
Here’s a checklist to see if you qualify for a gigantic backdoor Roth IRA:
- If you’re single or the head of household in 2022, you make more than $144,000, or $214,000 if you’re married filing jointly.
- Your solo 401(k), 403(b), or 457 plan, or your employer’s yearly 401(k), 403(b), or 457 plan, are both maxed out (k). In 2022, the pre-tax contribution limits will increase to $20,500 ($27,000 if you’re over 50), up from $19,500 ($26,000 if you’re 50 or older) in 2021.
- Optional, but in 2021 or 2022, you can contribute up to $6,000 in nondeductible traditional IRA contributions ($7,000 if you’re over 50).
- You can also make additional after-tax contributions over and above the yearly 401(k) limit of $20,500 ($27,000 if you’re 50 or older).
- In-service distributions a fancy name for withdrawal of these after-tax payments are allowed under your employer’s retirement plan. This is also a viable choice if you intend to leave your employment soon and move your money over to a Roth IRA.
Can I contribute $5000 to both a Roth and traditional IRA?
You can contribute to both a regular and a Roth IRA as long as your total contribution does not exceed the IRS restrictions for any given year and you meet certain additional qualifying criteria.
For both 2021 and 2022, the IRS limit is $6,000 for both regular and Roth IRAs combined. A catch-up clause permits you to put in an additional $1,000 if you’re 50 or older, for a total of $7,000.
What is the 5 year rule for Roth IRA?
The Roth IRA is a special form of investment account that allows future retirees to earn tax-free income after they reach retirement age.
There are rules that govern who can contribute, how much money can be sheltered, and when those tax-free payouts can begin, just like there are laws that govern any retirement account and really, everything that has to do with the Internal Revenue Service (IRS). To simplify it, consider the following:
- The Roth IRA five-year rule states that you cannot withdraw earnings tax-free until you have contributed to a Roth IRA account for at least five years.
- Everyone who contributes to a Roth IRA, whether they’re 59 1/2 or 105 years old, is subject to this restriction.