How to Max Out Your IRA

When considering retirement accounts, most military members think about the Thrift Savings Program. While the TSP should certainly be part of your overall retirement plan, it shouldn’t be the only part. You should also consider the advantages of another tax-advantaged option: the individual retirement account, or IRA. As such, we’ll use this article to explain how to max out your IRA.

Specifically, we’ll discuss the following:

• IRA Overview
• Roth vs. Traditional IRA
• How to Max Out Your IRA
• Final Thoughts

IRA Overview

Individual retirement accounts, or IRAs, serve as a tax-advantaged retirement account. Unlike qualified retirement accounts like 401(k) plans, IRAs do not have an employer sponsor. Instead, as the name suggests, any individual with earned income can open an IRA as a way to save for retirement.

Every year, the government declares an IRA maximum contribution amount, and individuals can contribute up to that amount annually (NOTE: this amount is regularly adjusted upward to account for inflation). Additionally, beginning in 2002, the government authorized a “catch-up” option for older savers. IRA account holders aged 50 or older can now contribute an extra $1,000/year – on top of the annual limit – to accelerate their savings.

IRAs also have the advantage of asset diversification. The TSP limits participants to A) one of five stock or bond funds, B) a target-retirement fund composed of a mix of those five funds, or C) a combination of both. With an IRA, savers have access to a far wider variety of investment options, including individual stocks, bonds, mutual funds, and exchange-traded funds, or ETFs. Furthermore, for experienced investors, self-directed IRAs also provide the opportunity to invest your retirement funds in alternative asset classes like real estate, cryptocurrency, and precious metals.

Roth vs. Traditional IRA

As stated, IRAs are tax-advantaged retirement accounts. But, two options exist for how you gain a tax benefit. With a traditional IRA, you contribute pre-tax funds. In other words, you don’t pay taxes on your contributions, so you reduce your current taxable income by every dollar contributed to the IRA (up to a certain income limit). While this saves you money now, it means that you need to pay income taxes on every dollar you withdraw in retirement. And, to ensure it gets its tax revenue, the government mandates that, at a certain age, people start withdrawing funds from their IRAs – known as required minimum distributions, or RMDs.

Alternatively, you can opt for a Roth IRA. With these accounts, you pay taxes on your contributions now, meaning you don’t save any money on your current tax bill. But, when you begin withdrawing funds in retirement, all of your contributions and their earnings come out tax-free, saving you money later. Additionally, as you’ve already paid taxes on Roth IRA contributions, the government doesn’t impose RMDs on Roth IRAs, which gives account holders far more financial flexibility in retirement and estate planning.

The Roth vs traditional IRA decision largely depends on your thoughts on future taxes. If you believe you’ll be in a lower tax bracket in retirement, taking the tax savings of a traditional IRA now may make more sense. Conversely, if you believe you’ll be in a higher tax bracket in retirement, paying taxes now and withdrawing them tax-free later likely makes more sense.

How to Max Out Your IRA

Take the Match First

Never say no to free money. That is, when it comes to retirement savings, focus your initial savings on accounts that provide some sort of matching contribution. If you have access to a workplace 401(k) or TSP, your employer also likely provides a dollar-for-dollar match up to a certain level (e.g. up to 5% of your income). Before focusing on your IRA, make sure that you contribute 100% of this match level. If you don’t, you’re giving away free money.

But, once you reach this match ceiling, maxing out your IRA frequently makes sense, especially for individuals in lower tax brackets. And, regardless of whether you opt for the traditional or Roth options, here are some techniques for maxing out your IRA every year:

Automatic Paycheck Transfers

With the military and most civilian employers, you receive two paychecks per month (24 per year). With direct deposit and current payroll software, you can set up an automatic transfer every payday for the pro rata amount of your annual IRA contribution. For instance, assume a $6,000 annual contribution limit. That translates to $250/payday ($6,000 / 24). If you set this up to automatically transfer every time you get paid, you A) will max out your IRA every year, and B) will never see that $6,000, meaning you simply build your household budget around never receiving those funds.

Monthly Transfers

This technique is similar to the payday one, but it accounts more for the realities of monthly bill pay. Most bills (e.g. rent, mortgage, internet, cell phones, credit cards etc.) come once a month. If you plan your cash flows around these bills, you can A) schedule all bills to be automatically paid the first of the month, and B) set up an automatic transfer to move $500 per month to your IRA several days later.

This technique has two advantages. First, it sets you up to max out your IRA (12 months x $500/month). But, by making the automatic transfer after you pay your bills, you also build in an emergency buffer. If, in a given month, your expenses come in more than expected, you have the flexibility to reduce that month’s IRA transfer. However, this should be a last resort, as reducing a monthly contribution means you need to make a catch-up contribution later in the year.

Annual Dump

For disciplined savers, this option often makes sense. Rather than making contributions throughout the year, you set money aside in a separate account all year (e.g. a savings account). Then, on Jan. 1st, you can contribute the entire allowed amount to your IRA. This provides the advantage of longer investment exposure, which amplifies the positive effects of compound interest.

If you spread annual IRA contributions over the associated tax year, you don’t have all your funds working in the market for the entire year. Conversely, by making an annual dump of the entire amount on the earliest allowed date – Jan. 1st of the associated tax year – your funds work for you (i.e. reap the benefits of compound interest) the entire year. Put simply, the more money you have invested earlier, the more it will grow over time.

NOTE: Many investors subscribe to a dollar cost averaging approach, which means contributing smaller amounts over a longer period to account for the volatility of stock prices. While this approach may decrease the likelihood of short-term losses, a recent Vanguard study found that a lump sum approach leads to greater long-term returns than dollar cost averaging roughly two-thirds of the time. Furthermore, making one contribution per year over 30+ years of retirement savings effectively acts as dollar-cost averaging over your entire savings period – just at an annual interval.

The “Windfall Approach”

This is a less structured approach, as it depends more on factors outside of your control. Rather than build your budget around making IRA contributions – at any of the above intervals – this technique focuses on financial windfalls. That is, when you receive an irregular or unexpected sum of money (e.g. annual bonus, tax refund, inheritance, insurance payout, scratch-off lottery win, etc.), you use those funds to max out your IRA.

This approach has the advantage of not disrupting your regularly monthly budget. But, it also has the major disadvantage of unreliability. That is, by their nature, windfalls may or may not happen. If you can’t reliably plan for a sum of money, it’s difficult to guarantee that you’ll have available funds to make your annual IRA contributions.

Leverage a Side Hustle

This is less an IRA contribution timing technique and more of a funding one. Unfortunately, many of us look at our paychecks and ask: Where am I supposed to come up with thousands of extra dollars to max out an IRA?

Side hustles can solve this problem. Whether it’s driving Uber, selling items online, walking neighborhood dogs, tutoring kids, or any other one of a countless number of side hustles, most people have ways to make some extra cash. If you look at a side hustle not as a few extra dinners out, but your annual retirement savings, the money you earn from these gigs can be a great way to max out an IRA.

Final Thoughts

After meeting an employer 401(k) or TSP match, maxing out your IRA is a great way to save for retirement in a tax-advantaged account. And, individuals have a variety of options for doing so, from regular paycheck transfers to annual contributions. But, regardless of what approach you use, the key takeaway is the importance of maxing out your IRA every year. By always hitting your annual contribution maximum, you’ll dramatically increase your likelihood of a financially stable retirement.

Maurice “Chipp” Naylon spent nine years as an infantry officer in the Marine Corps. He is currently a licensed CPA specializing in real estate development and accounting.