Reasons to fund your IRA early

[Honest Abe]

This is a cool article... The average benefit of funding your IRA immediately is $705/yr!

https://www.betterment.com/blog/2013/02/05/the-early-bird-gets-705-more/

[sherr]

That is an interesting point, but it's not in anyway limited to IRA accounts. Paying an extra $5,500 off your mortgage at the beginning of the year will have more of an effect than paying the same amount at the end of the year. A more general rule would be that the best thing is to put as much money as you can as early as you can into the the account with the highest interest rate that you can find, be it debt or investment.

If you have the ability to put all $5,500 in your IRA at the beginning of the year but choose instead to contribute once-a-month to the IRA and put the rest into paying off your mortgage, for example, then the opportunity cost is much less that what is stated in the article. You'd have to be sitting on your money not doing anything with it in order for those numbers to be strictly accurate.

Not that I think it's a bad idea since IRA / 401k are usually one of the best forms of investment available. But front-loading your IRA / 401k does expose you to additional risk of market volatility that is mitigated by dollar-cost averaging, and the benefits for doing so are much reduced if you actually do *something* else with your money. The advice should be taken with a grain of salt is all.

[Chris]

One reason to hold off on making contributions early is if you're nearing the MAGI limit for contributions. It's a hassle to pull it back out before the following tax season (if you even remember).

But if you're well under the income limit, by all means, contribute early.

[MrSaturday]

Bogleheads says that Investopedia says that lump sum investing beats dollar cost averaging 66% of the time, but I don't see a citation for a specific study that came up with that.

This was the first year I was prepared to max my Roth at the beginning of the year, so I went ahead and dumped the full $5500 into my Vanguard funds on the morning of Jan 2nd.

[sol]

I'm confused about how front loading gives you a return boost that is greater than the average annual market return.  Maybe they're comparing a full contribution for next year on Jan 1 vs a full contribution for last year on Dec 31?

[dragoncar]

I'm confused about how front loading gives you a return boost that is greater than the average annual market return.  Maybe they're comparing a full contribution for next year on Jan 1 vs a full contribution for last year on Dec 31?

I'm not sure either... when I run the numbers, it's $1340 / year.  I think this is due to compounding of the initial gain, plus sequencing... the CAGR for 1990-1999 was almost 18%.

[strider3700]

Could it have anything to do with getting in a few extra dividend distributions?

[hoppy08520]

I'm confused about how front loading gives you a return boost that is greater than the average annual market return.  Maybe they're comparing a full contribution for next year on Jan 1 vs a full contribution for last year on Dec 31?

I think the reason front-loading is better in the long run is that your full contribution is earning/compounding tax-free all 12 months, rather than adding more gradually each month.

Let's say we're looking at three options for contributing to your IRA for tax year 2013. The contribution limit is $5,500 for tax year 2013. Ultimately you want that $5,500 in your IRA. To make this a fair comparison, in this scenario we assume you have $5,500 invested in a taxable account in a particular fund, and you will choose the same fund when that money is in your IRA. So, effectively what you're doing with every IRA contribution is moving a dollar from a particular mutual fund in a taxable account to the same mutual fund in your IRA. The question is, when do you transfer the $5,500 into your IRA?

Here are three options: Good, Better and Best:

Good:
On April 14, 2014 (next year), make a $5,500 contribution to your IRA for the 2013 tax  year. This is the last day you are allowed to contribute for the prior year. This is for the procrastinators.

Better:
All through 2013, contribute every month to your IRA for the 2013 tax year, which would be 12 equal monthly deposits of $458.33.

Best:
On Jan 1, 2013, contribute $5,500 toward your 2013 IRA.

Why is the last option the best? Let's fast forward to 4/15/2014.

With the "Good" option, your $5,500 has been compounding tax-free for all of 1 day.

With the "Better" option, your $5,500 has been compounding tax-free progressively more and more each month as you contribute throughout 2013.

With the "Best" option, your $5,500  has been compounding tax-free for a full 16 months.

This is why people with money sitting around will front-load their IRAs with a full contribution on Jan. 1. If you have $5,500 sitting around, you'd rather it sit around in a tax-advantaged account than in a taxable account.

Dollar cost averaging (DCA) considerations are not relevant in this scenario because we're assuming that your money is invested in the same way in a taxable account as it is in the IRA.

One possible consideration is if you're on the fence between doing a deductible traditional IRA and a Roth IRA, or if you're not sure if you'll exceed the deductible Traditional IRA or Roth IRA income limits, or if you might to do a mix of deductible IRA and Roth IRA in the same year. In these cases, some people will wait for the tax year to be over, and then strategically contribute to IRA(s) in a manner to optimize their tax situation once all your income and tax data are final.

Many people will also front-load their 401(k) contributions for the same reason, although you  need to make sure that in doing so you don't accidentally miss out on the full employer match. This can happen if you employer matches your contributions up to a maximum amount in each paycheck. In that case, you need to make sure you contribute enough every paycheck.

[Jack]

One possible consideration is if you're on the fence between doing a deductible traditional IRA and a Roth IRA, or if you're not sure if you'll exceed the deductible Traditional IRA or Roth IRA income limits, or if you might to do a mix of deductible IRA and Roth IRA in the same year. In these cases, some people will wait for the tax year to be over, and then strategically contribute to IRA(s) in a manner to optimize their tax situation once all your income and tax data are final.

In this case, wouldn't the optimal plan still be to go ahead and make all the contributions on January 1st (for the current year, not the one that just ended), then recharacterize as needed when you do your taxes?

[chucklesmcgee]

One reason to hold off on making contributions early is if you're nearing the MAGI limit for contributions. It's a hassle to pull it back out before the following tax season (if you even remember).

But if you're well under the income limit, by all means, contribute early.

Or just do a backdoor contribution.

[dragoncar]

One reason to hold off on making contributions early is if you're nearing the MAGI limit for contributions. It's a hassle to pull it back out before the following tax season (if you even remember).

But if you're well under the income limit, by all means, contribute early.

Or just do a backdoor contribution.

I always go for the backdoor.  The only problem is that some people have deductible IRA contributions from prior years.  This screws things up.