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Get a head start on your Roth IRA in 2013

by retirebyforty on January 18, 2013 · 16 comments

in investing, retirement

Roth IRA head start 2013Good News! The IRS raised the contribution limit for both the 401(k) plan and IRA by $500 this year. They also raised the income limit for the IRA so if you’re borderline, you should check with the IRS if you can contribute more this year. This increased limit is great because we can save more for retirement and I’m sure many of us made a New Year’s resolution to save more in 2013.

Roth IRA

The Roth IRA is a particularly good saving vehicle for workers who are already participating in their company’s 401(k) plan. For 2013, workers can contribute $5,500 to their Roth IRA. The great thing about the Roth IRA is once you satisfy the requirement, then you won’t have to pay any tax in that account. You can also withdraw your contribution without penalty at any time in case you need some money. The Roth IRA will give you more options to deal with taxation when it’s time to withdraw in retirement. Most of us have some retirement saving in a pre tax account like the 401(k) plan. When you withdraw the fund from the 401(k) plan in retirement, you will have to pay the regular income tax rate. If you have some saving in the Roth IRA, then you can minimize tax by mixing the withdrawal and avoiding the higher tax brackets.

Where to get $5,500?

There are a few ways to contribute to the Roth IRA. One is to contribute every month from your savings account. This is good because you can take advantage of dollar cost averaging and invest throughout the year. On the other hand, I like to contribute in one shot at the beginning of the year. Like most investors, I sold some investment near the end of 2012 so I can offset some gains. Instead of reinvesting everything, I set $5,500 aside for the Roth IRA. Now that it’s 2013, I can just transfer that $5,500 into my Roth IRA and wait for a buying opportunity. It may sound like I’m playing a shell game by just moving money around, but why pay tax when you don’t have to?

Investing early can be beneficial

A Vanguard study has shown that investing in a lump sum early on is better than dollar cost averaging. Historically the stock market rises so over the long run so the lump sum has more time to take advantage of the market gain. This is one reason to set aside $5,500 and plow it into the Roth IRA early every year. How about you? Did you make a New Year’s resolution to save more for retirement? If you did, why not go ahead and finish off the Roth IRA early? Getting one item out of the way will make financial planning a little bit easier the rest of the year.

*Assumptions

  1. I’m assuming an investor will have earned income in 2013 so they can contribute to the Roth IRA.
  2. If you are near the income limit line, you probably should wait until the end of the year before contributing so it will be simpler.
  3. As Steve pointed out – watch out for the wash sale rule. Don’t sell an investment at a loss in your taxable account and purchase the same investment in an IRA within 30 days. You can’t take the tax deduction if you do this.

{ 16 comments… read them below or add one }

South County Girl January 18, 2013 at 6:50 am

Unfortunately I have to kind of do the “dollar cost average” because we just don’t have that kind of money sitting around outside of our emergency fund… but since i’m paid bi-weekly and budget on 2 paychecks a month, twice a year I can dump in $1100 so the monthly amount I have to stock away isn’t that much. Some months I wait and stock up the funds so I can make a nice round larger deposit… so I guess i’m doing a bit of both?

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T3 January 18, 2013 at 2:04 pm

Have you thought about counting your Roth as part of your emergency fund? That way you can just move the money out of your emergency fund into your Roth guilt free–and then use savings each month to stock up your emergency fund again if you deem necessary.
From what I’ve read if you put cash into the Roth you can take out your contribution anytime (if you roll it from another account you have to wait 5 years), shouldn’t that meet the criteria to qualify for an emergency fund?
I’m interested in hearing thoughts as I’m in a similar situation and trying to make the “smart” decision.

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retirebyforty January 19, 2013 at 10:58 pm

No, I like to keep the retirement account separate. That’s for the future. It’s simpler for me.
Anyway, the emergency fund should be liquid. You don’t know what can happen with the stock market.
If you need your EF and the market is down, then you’ll be forced to sell at a loss.

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retirebyforty January 19, 2013 at 10:52 pm

Dollar cost averaging is a good way to invest too. I did that with my 401k and it worked out well.

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Steve January 18, 2013 at 8:17 am

When selling at a loss in December and contributing to an IRA in January, one should make sure one doesn’t fall afoul of the wash sale rules. Wash sale rules are generally just an annoyance, but in this case, it would convert a taxable loss into a basis adjustment on an account that doesn’t have a basis.

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retirebyforty January 18, 2013 at 8:59 am

Thanks for the reminder. I’ll update the post to state that. I assumed most investors would purchase a different investment after taking the loss, but that’s not universal.

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Suba January 18, 2013 at 3:24 pm

Unfortunately we might have to stop almost all our retirement contributions this year. We have to get a good amount of money ready for a downpayment if we want to buy this year. And with losing my income, it is a fight. Hopefully by next year we will be in a better position and catch up.

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retirebyforty January 19, 2013 at 10:58 pm

Sorry to hear that. Hope you get back into the groove next year.

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Lance @ Money Life and More January 19, 2013 at 8:35 am

I personally dollar cost average. If I saved up money to put in a Roth a year ahead of time it’d just be missing out on participating in the market so I just put it in throughout the year. If I did have a lump sum available though I would consider it. I’d also be worried that maybe I was buying at the high point for the year though.

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Jane Savers @ The Money Puzzle January 19, 2013 at 5:48 pm

Vanguard etfs have come to the Toronto Stock Exchange so I will be putting some money with them inside my RRSP (registered retirement savings account). I have heard so much about from American writers.

I don’t usually invest in funds because I do not like to pay fees but I may give it a try. It will be a small investment because I am still paying down debt but it is a start.

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retirebyforty January 19, 2013 at 11:09 pm

That’s great news! Once you take care of your debt, then Vanguard ETFs will be a great start.

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Derek January 20, 2013 at 3:56 pm

It’s a great idea to get a jump on our retirement fund this year already. Great post RB40!

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Elizabeth @ Broke Professionals January 20, 2013 at 5:10 pm

Like some of the previous commenters, I dollar cost average too, more out of habit than anything else. I have a plan in place to get the $5,500 max contribution this year, though, and I never thought about the potential benefits of putting everything in a lump sum in January. I have the cash on hand to make that deposit now, though, so it’s worth contemplating.

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retirebyforty January 21, 2013 at 10:04 pm

It might be worth it if there is a big market correction. Good luck. :)

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Miss T @ Prairie Eco-Thrifter January 20, 2013 at 6:42 pm

My husband and I are working to set-up pre-authorized withdrawals to our tax free accounts for 2012. This will end up dollar cost-averaging, rather than throwing a lump sum, for us as well.

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retirebyforty January 21, 2013 at 10:05 pm

That’s great. Dollar cost averaging is good too.

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