Don’t Underestimate the Power of IRA Contributions
Although IRAs are designed to help investors build their retirement savings, a recent report from the Investment Company Institute (ICI) found that while the majority of US households are eligible to open an IRA and make IRA contributions, few do so.
In tax year 2014, the ICI found that only 14% of all US households made contributions to IRAs, compared with 12% in tax year 2013.
While the number of households making contributions rose significantly when the ICI looked only at households that own IRAs, the figures still showed that the majority IRA owners do not make annual contributions. The report found that 43% of households owning IRAs in mid-2015 made contributions in tax year 2014, compared with 34% in tax year 2013 and 39% in tax year 2012.
Source: Investment Company Institute Annual Mutual Fund Shareholder Tracking Survey and Investment Company Institute IRA Owners Survey
The good news is that the number of households making IRA contributions has risen since 2012, but why do IRA contribution levels remain low?
The ICI cited a number of factors, including rules limiting the ability to make deductible contributions and the fact that some IRA owners are retired. Another reason is that some investors feel they are meeting their retirement savings needs through employer-sponsored retirement plans, like 401(k)s.
It’s true that there is a large disparity between annual contribution limits imposed on IRAs versus 401(k)s. Given this, many investors overlook the opportunity to contribute to an IRA thinking that they have already contributed to their 401(k).
But working at PENSCO, where we custody alternative assets in more than 48,000 self-directed retirement accounts, I have seen the ability of small IRA contributions to grow into large nest eggs. Here's why: Holdings in a traditional IRA can compound year after year on a tax-deferred basis and can grow that way until required minimum distributions must start when an account holder turns 70½.
The chart shown below captures the growth trajectory of $100,000 invested in a tax-deferred account where the account holder makes annual contributions of $5,500.
As the chart shows, an IRA, supplemented with annual contributions, can be a powerful way to save for retirement. While every investor needs to determine for themselves the best way to build a retirement nest egg, it might pay to take a second look at how IRA contributions can help you meet your long-term investment goals.
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