Saturday, January 10, 2009

IRA Contributions 2008 & 2009

History has shown us the benefits of funding Individual Retirement Accounts (IRA) on an annual basis. In a world where corporate pensions are becoming a thing of the past, it is our responsibility to put money aside for future needs.

The creation of social security in 1935 has evolved into the de facto retirement plan for many Americans. The intent of the original social security act though was not to be the sole source of retirement funds, but rather a compliment to other sources of income. It was to replace a portion of your salary. This is exactly how the system works today. The bigger question should be - what other sources of income will I need to compliment my retirement?

Opening and/or funding an IRA is one way to enhance your retirement plan. Contributing to your account every year as well should be mandatory. If we set aside the emotional issues resulting from 2008, capital markets go up more than down.

Since 1952, the S&P500 has increased 35 out of 56 years (63%). If we were talking baseball, American capitalism would be in the hall of fame!

Another factor rarely discussed when talking about IRA accounts pertains to when is the ideal time to fund your account? Sometimes investors think they can time the market. Sometimes cash isn't readily available. For most though, it's simply a matter of habit. They tend to make contributions for the previous year when they file their 1040 income tax return.

Let's take things a step further: What happens if you fund your account on January 1 every year for the CURRENT year as opposed to April 15 for the PREVIOUS year? Does the extra 1 year of compounding each year make much of a difference? You bet! Let's take a look.

For our example, let's assume the S&P500 has an annual return of 8% per year. Since we are not going to fund a retirement account for 56 years, we'll assume a 25 year investment period. Funding your IRA with today's $5,000 limit at the beginning of each year (January 1) would yield an ending balance of $394,772. Should you file at the end of each year instead, your account balance would be $365,529. This represents a significant difference... $29,242! By simply funding your IRA at the beginning of each year and putting time on your side (remember the S&P500 historically has increased 63% of the time since 1952) makes a significant difference.

Some investors will prefer dollar-cost-averaging as monthly investments are easier on their budget. This is logical and makes good financial sense. Others choose to make lump sum investments once per year. It is these individuals who should note the benefit of making contributions in January for the current year - every year. Put time on your side and reap the rewards!

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