Fund Your Roth IRA Early This Year
Back in early March, I decided to fund our Roth IRAs for 2007. That’s right, this was not a late funding for 2006, I already did that back in december, this was early funding for 2007. By putting the money to work early we allowed it to begin compounding early. Given how well the market has been doing lately, I wondered how much that decision has been worth.
As I’ve said before, I keep all my financial information in Quicken, so it’s easy to go back and look at all previous decisions and see if they were good or bad. On March 9th we purchased $8,000 worth of the Vanguard S&P 500 Index Fund, that’s $4000 for me, and $4000 for my wife. The cost of shares back then was $129.62 and we purchased 61.718 shares. As of Friday (April 20th) shares closed at $136.77, so we made $7.15/share or $441.28 in a bit over a month. Sweet! Because this money is in our Roth IRA we will never owe any taxes on those gains, provided that money stays in the account until we turn 65.
Now we have $8441.28 instead of $8000 growing for the next 20+ years simply by putting that money in early rather than later. If we had waited to fund our Roth IRA we’d have missed that gain. But remember even those folks who waited to fund their 2006 contribution until April 15th missed that $441 gain, but they missed it with both their 2006 and 2007 contribution. Thus my wife and I are $882 richer than if we had waited until the last minute, because we funded early in both 2006 and 2007, and it’s all tax free, my favorite kind of money.
Let’s look at an extreme case, if you had funded your 2006 contribution on Jan 1st 2006 S&P 500 shares would have cost you $116.82/share, on April 16th 2007 those shares were worth $135.30/share. That’s the difference between a Roth IRA worth $9,265 and one worth $8,000. It’s actually even a greater difference because there would be reinvested dividends probably worth about another $100 or so.
Let’s not forget those tax advantages. If you had left that money in your taxable account you might have to report another ~$1300 in income at the 15% cap gains rate that’s another $200 in taxes you’d have to pay.
The moral is, when you are deciding where to invest your money, fund your Roth IRA first, get that money into the Roth Protection in a good safe long term investment as soon as you can, and out of your taxable accounts. The difference could be significant, you want every dollar out there working as hard as it possibly can. That way you won’t have to.
This post was included in this week’s Carnival of Personal Finance over at We’re in Debt.
May 14th, 2007 at 2:00 pm
Just to clarify, you actually can start taking distributions from your Roth IRA at age 59 1/2, not 65. (http://en.wikipedia.org/wiki/Roth_IRA).
Also, fully funding your Roth IRA all at once is definitely one option, but if you invest it all at once and the market goes down, then you’re out a bunch of money at once. What I prefer is known as dollar cost averaging (http://en.wikipedia.org/wiki/Dollar-cost_averaging), which essentially recommends putting a fixed amount into your investment each month. This way, if you put in $333 a month for 12 months (which adds up to $4,000), when the market is down you get more shares per dollar, when the market is up you get fewer shares per dollar. Over the long run you’ll end up with more shares than if you invested it all at once.
Just a thought!