For IRAs, Time Is Money

A retirement savings contribution made now is much better than one made later. That's a principle that can make a tremendous difference in the amount of savings you are able to accumulate before you retire. Those who contribute to an IRA sooner rather than later in the year will have much more over the long term. That's even if an early investor ends up contributing the same amount as someone who waits until the last minute. Read on to learn about how a few months of procrastination can add up to thousands of dollars of lost savings.

Meet Tom and Elvis
We speak here of two types of IRA owners. Tom Tardy waits until the last day to contribute to his IRA, which in most years is April 15. However, Elvis Enseguida fully funds his IRA the first day of the new tax year, or January 1, getting about a 15-month head start on the compounding of his investment. Suppose the pair does this every year for the next 30 or 40 years.

Both Tom and Elvis will do well. That's because they realize the importance of compounding in a tax-deferred environment. However, one will do considerably better than the other over the long term, even though they'll both end up contributing the same amount.

Elvis, who makes his full contribution on January 1, will take full advantage of the power of compounding. Over the long term, his money will literally have more years to accumulate interest. That's how money starts to create money, making a do-it-now person wealthy.

The Early-Bird Bonus
Elvis Enseguida will end up with much more than Tom Tardy. Let's say both put $5,000 a year in their Traditional IRAs. (We will not use Roth IRAs in this example.) They both earn 5% per year on their investments. They both contribute the same amounts over the next 30 or 40 years, but Elvis gains 15 months of additional compounding for each contribution every year. Over the short term, the difference isn't much. Over the long term, financial advisers say, the difference is significant.

At a 5% rate of return, Elvis has some $16,000 more than Tardy after 30 years ($353,890 vs. $337,355). After 40 years, he has some $34,000 more ($643,447 vs. $609, 293).

If $34,000 seems like nothing of significance over 40 years, remember that 5% is a relatively low rate of return for our example. Let's use a higher number.

The 9% Solution
The historic long-term return of the stock market has been about 9%. So let's project out 30 and 40 years and see how Tom Tardy and Elvis Enseguida do. The difference between early and late IRA contributions at 9% is some $75,000 and $193,000 over the long term.

After 30 years of last-minute $5,000 IRA contributions, Tom Tardy will have some $687,000, but Elvis Enseguida will have some $762,000. Over 40 years, the difference will be in the hundreds of thousands of dollars; Elvis will have $1,889,797 while Tardy has $1,696,998.

So, the sooner investors make contributions, the better off they will be.

Even those who contribute just a little early will benefit from the just-do-it principle. Say you were only 3.5 months early with your contribution. You fully fund an IRA on January 1 instead of April 15 each year. Assuming the same returns - 9% a year over 30 and 40 years - again the difference is significant.

Over 30 years, you have some $30,000 more and over 40 years it comes to $45,000.

There's Still Hope for the Tardy
But let's say you are Tom Tardy and you're approaching the golden years. You missed the opportunity in your 30s, 40s and 50s to maximize your IRA balance. You didn't contribute as much as you could have and usually put in $2,400 a year when others were putting in $4,000 or $5,000 a year. Now you're in your mid 50s and seem a little short on retirement savings.

There's still hope for the Tom Tardys, especially those who intend to work part time in retirement. At age 59.5, when many people are starting to draw down their IRA accounts, you can be different, notes Jim Lange, a CPA and attorney in Pittsburgh and the author of "Retire Secure!" (2006).

Access your taxable accounts, such as your mutual funds or savings outside of your IRA or other qualified accounts, but leave the IRA account alone for a few more years, Lange says. In fact, think about adding to the IRA. The rules say you can access your IRAs without penalty at age 59.5; rules don't say that you must.

In fact, if you're making a small earned income in retirement - maybe you have a part-time job - you can continue to contribute without making any required minimum distributions right up until age 70.5.

That's when the government halts the retirement savings break and requires that you start taking some money. But some additional years of compounding can be tremendously beneficial - as beneficial as for the young person who makes his or her IRA contribution early each year.

Ten More Years
So let's say that at age 55 you don't retire, but you slow down. You work a little each year and decide to put $2,400 a year into your IRA for another 10 years before beginning to draw it down.

This will make a pig difference. Indeed, this Tom Tardy who contributed $2,400 a year and earned 7% a year for 30 years will have $229,318 at age 55. Tom, at age 55, realizes that he is not going to have enough to retire at age 59.5, so he decides to contribute $2,400 a year for 10 more years through age 65.

What is the difference in 10 years worth of extra contributions and compounding? About $273,000 ($502,810 vs. $229,318). Still, let's say he can get 9% instead of 7%. The difference is now some $532,500 ($330,000 vs. $862,500).

Pigs Get Slaughtered
By the way, the difference at a 12% rate of return is monstrous: $1,997,000 vs. $583,000, but don't get piggy in selecting retirement investments. That's when investments can often blow up, advisers say.

So whether you are a Tom Tardy or an Elvis Enseguida, whether you have been doing a great job or not, the compounding option exists.

But the option only exists if you use it: So just do it. Just do it now.