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.