IRA Procrastinators, Start Here

Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar. IRA season is upon us. Investors have until April 15 to make a contribution if they want it to count for the 2019 tax year. Joining me to share some tips, if you are among those trying to squeeze in a last-minute contribution, is Christine Benz. Christine is director of personal finance for Morningstar. Christine, thanks for joining me today.

Christine Benz: Susan, it's great to be here.

Dziubinski: Investment firms report every year that they see this spike in folks making contributions to an IRA right before that filing deadline. And so your first tip is: Stop procrastinating.

Benz: That's right. And this is one area where I say don't do as I do, do as I say, because I'm among those procrastinators sometimes where I'm rushing in my IRA contributions for myself and my husband. But be careful about this because especially if you have a very long time horizon until retirement, even those missed months can stack up over a period of time. I mean, think of really great market years like we've had recently, like last year where if you miss just a couple of months, that's a big deal over time. So, there's the prospect of forgone investment returns. It's also just much simpler to come up with the cash on a monthly basis versus one heavy lift right before April 15. My advice is to automate this if you possibly can, put yourself on a dollar-cost-averaging plan. We have nice, even IRA contribution limits currently where it's $6,000 for people under age 50. That means $500 a month will get you to that maximum contribution amount for 2020. Go that route and spare yourself the last-minute scramble.

Dziubinski: Another tip that you have is to do your homework when you're choosing between whether you should be investing in a traditional or a Roth IRA. Which one should we be thinking about?

Benz: Well, I think a lot of people reflexively choose the Roth, and there is certainly a lot to like about Roth in terms of tax-free withdrawals in retirement, no required minimum distributions--a couple of big attractions. But either work with a tax or financial advisor or do your own homework on your tax rate at the time of contribution versus what it will likely be or possibly be in retirement. For people who are getting close to retirement, who haven't yet saved a lot for retirement, they may be surprised to learn that actually traditional IRA contributions when that tax break is more valuable to them because they're still working and have an income, will be more valuable to them than taking it in retirement when their tax bracket is lower. So, the traditional IRA contributions for someone in that situation, which isn't an uncommon profile given how undersaved many of us are for retirement, that'll be better than making Roth contributions.

Dziubinski: Now let's pivot to income limits. Another tip is to assume that you aren't necessarily shut of an option because of an income limit. Is that right?

Benz: That's right. There are income limits that relate to whether you can deduct a traditional IRA contribution on your tax return or whether you can make a Roth IRA contribution. Roth IRA contribution limits are higher than are the limits for deductible traditional IRA contributions. But a lot of people might see the higher Roth income limits and stop right there and say, "Oh, my income is well over that level, I guess I can't do it." Well, the answer to that is what's called the backdoor Roth IRA. And the basic idea is that you fund a traditional IRA--you can't deduct it on your tax return because you automatically earn too much if you earn too much to contribute to a Roth IRA. But you're funding that traditional IRA, then after a period has elapsed--and tax experts differ about how much time to let go, but you could do this fairly quickly after initially funding the account--you convert those dollars to a Roth IRA.

So, it's a way for people who have not been able to fund a Roth IRA to get some assets over into the Roth column. Do check with a tax advisor on this, though, because there's this thing called the pro-rata rule, and I won't get too into the weeds in terms of explaining what it is. But for people who have a lot of traditional IRA assets or 401(k) assets, essentially money that's never been taxed, that's sitting in tax-deferred accounts. The fact that you have those assets can affect the taxation of even the small amount that you are trying to convert to a Roth. So a good spot to get some tax advice.

Dziubinski: And another tip is that an investor shouldn't assume that he or she is being shut out of a vehicle because they have no earned income.

Benz: Right. An important criterion when you are contributing to an IRA is that you do have to have earned income. But if you are married and your partner has earned income, even if you yourself don't have earned income, he or she can make that contribution in your name, in the form of a spousal IRA. So take advantage of that. It's an especially important point for parents where you've got one nonearning spouse who's really doing the heavy lifting on the home front and another spouse who's earning an income. Make sure that you're putting money to work on behalf of the nonearning spouse. You'll really be grateful that you did when retirement rolls around.

Dziubinski: Another tip is that investment firms have noticed that people will open up IRAs, but then they don't actually invest the money in anything or it takes a while for them to do that. So what should people be thinking about getting that money invested in sooner?

Benz: Well, I would say just as you're trying to automate those contributions, I would say also get the investments automated as well. To me a really simple solution is just to use a target-date fund to help make sure that your money is invested in an age-appropriate mix. So select one that roughly corresponds with your retirement date. That would be a quick-and-dirty solution. Another idea if you have a little bit more time is to take a look at all of your retirement assets in aggregate and see where you've got some holes. 

For many people looking at their portfolios today, if they haven't been doing much repositioning, chances are they're light on the safe stuff because we've seen very aggressive investments perform well. You may want to add to bonds, you may want to add to cash if retirement is close at hand. You may want to add to foreign stocks because we have seen foreign stocks generally underperform U.S. even though they did great in 2019. Smaller-cap and value stocks might be other sort of holes that you might find in your portfolio, areas that you might want to top up with your new IRA contributions.

Dziubinski: Christine, thank you so much for these tips for procrastinators like us today. We appreciate it.

Benz: Thank you, Susan

Dziubinski: I'm Susan Dziubinski for Morningstar. Thanks for tuning in.