Updated January 2022.
Are you one of those people who says, “yeah, I want to be a millionaire.” Well, if you’re not going to inherit a bundle of money and accept that winning the lottery may not happen, then contributing to your IRA might be a very good idea. It could get you closer to that elusive milestone. Here’s why a Traditional IRA is a no-brainer.
The big Benefit of an IRA
The main advantage of your Traditional IRA is that earnings in the account don’t get taxed until you pull them out…ideally decades from now.
Deferring those taxes means that every penny in your account can work for you.
Think about what happens to investment earnings in a taxable account. You keep just 72 cents of every dollar your investments earn (assuming a 28 percent tax rate).
Here’s what six percent would net after a year inside and outside an IRA if you pay 28 percent in income taxes.
Now think about this impact over time.
The Return you Earn on Your Investments’ Returns
Your investments earn a return. That gets added to your balance. That balance earns a return. This is called “the power of compounding.”
That compounding will continue for as long as you keep funds invested up to and beyond the time you retire. What stays in your account after you start withdrawing money in retirement will keep compounding. And this process can turn into a lot of money – even when returns are modest.
For example, notice how two identical $10,000 investments perform after 30 years in an IRA and a taxable account.
The future value of the IRA (a little over $54,000) is nearly 59 percent greater than the taxable account (about $34,000). This is because all the returns in the IRA are available for compounding. Returns in the taxable account get reduced by 28 percent to pay taxes.1
Now let’s look at what happens when you contribute to your IRA regularly.
Battle Rhythm your IRA Contributions
Your IRA contributions need to be part of an ordered routine. Think of them the way you prepare lists and make decisions. You want to have a certain lifestyle in retirement, you can’t get there without a solid nest egg, you aren’t there yet, so you need to save. Boom!
Regular annual contributions are the way to execute this plan.
Consider this. Someone making annual IRA contributions of just $6,000 ($500 a month) over 30 years and achieving an average annual return of six percent would accumulate more than $500,000.
The combination of tax-deferral, consistent annual contributions and compounding would get this IRA half way to the million-dollar mark.2 If this person also contributed to other types of retirement accounts, then having a million dollars at retirement is realistic outcome.
But wait. There’s more!
Tax Benefits on the Double
You may be able to deduct some or all of your IRA contribution. There are a lot of variables around this, but IRA rules and regs shouldn’t be too taxing (no pun intended) for you.
Deductibility depends on your filing status, income, and whether you or your spouse is covered by a retirement plan at work. If you’re planning on making an IRA contribution in 2022 for a tax year 2021 deduction, please note that the income limits in 2021 are $2,000 ($4,000 for joint filers) lower than the amounts listed in the table for 2022.
Okay, one last point on IRA contributions. The amount you can contribute to your Traditional IRA is limited to $6,000 ($7,000 if you’re over 50). But if you can’t afford that, then contribute whatever you can!
How Should you Invest Your IRA?
Wondering how to invest your Traditional IRA contributions? We can help with that. Our Investment Specialists understand the questions people have about funding retirement accounts. Call us at (800) 235-8396.
1 It is important to note here that rates of return and tax rates are hypothetical illustrations intended solely to demonstrate the power of tax-deferred compounding.
2 Remember this is an illustration and not indicative of actual returns on real investments. The point is simply to show how compounding works. Your actual results will vary based on the real-world inputs of your unique financial circumstances. You should seek the advice of a qualified professional financial advisor.