One of your New Year’s resolutions might be to save more money and build wealth more quickly. That might tempt you to front load your retirement contributions this year by making most or all of your contributions in the first month or two of the year. Before you do that, however, consider some reasons why you may want to wait and spread out your contributions throughout the year:
1. You think we’re headed for a downfall
So you want to front load your investments because you think the market is going to tank. No matter how many times I show physicians that market timing and stock picking are unlikely to generate higher returns in the long run, most of the time behavioral biases tend to outweigh empirical data.
According to Standard and Poors SPIVA scorecard which tracks the performance of mutual funds relative to benchmarks, the majority of mutual funds underperformed their respective benchmark over the past 10 years in various asset classes.
If you choose to ignore the evidence and you think the market will go down later this year, then you should wait to make contributions. Just make sure you clearly define the parameters that guide your decision.
2. You might need the cash
In last month’s article I recommended that you increase your cash reserves because of the potential huge financial obligations you might be facing in the first few months of the year. These include the last estimated tax payment for 2015, the first estimated tax payment for 2016, federal and state income taxes for 2015, and remaining retirement plan contributions for 2015. If you ignored that advice, then here are steps you need to take now to estimate your first few months obligations:
- Figure out your gross income for last year
- Multiply that by 35% — this is a very rough idea of federal and state income taxes for 2015
- Calculate the total income taxes withheld on your paystubs and estimated taxes you paid
- Subtract #3 from #2: this is how much you may owe in April 2016
- Figure out the maximum retirement plan contributions you can make for 2015
- Calculate the actual contributions you made
- Subtract #6 from #5: this how much more you might still be able to contribute for 2015
- Add #4 and #7 and then add first estimated tax payment for 2016: this gives you very roughly total obligations you owe by April 2016.
3. You might switch jobs
Suppose you are an independent contractor and you’ve set up a SEP IRA as your retirement plan. Suppose you also read my article last month and built up some cash reserves for the obligations coming due in April. You go ahead and max out your 2016 SEP IRA this month for $53,000 because you assume that you’ll make a certain amount of income this year.
But then in a few months you decide to change groups and you become an employee. Now your independent contractor income is much lower for 2016 and you’ve over-contributed to your SEP IRA. In this case you have to remove the excess contribution and any potential gain on the excess contribution. It’s not terribly difficult to do but it’s another headache you don’t want.