The Best Time to Invest in a Roth IRA

Timing is key to maximizing the tax benefits of a Roth IRA

Investing in a Roth IRA is like sending a gift to yourself in the future. These individual retirement accounts (IRAs), unlike their traditional counterparts, are funded with after-tax dollars, meaning that you pay the Internal Revenue Service (IRS) up front rather than when withdrawing funds later.

Why would you want to do that? Well, for one, with a Roth, your compounding earnings grow tax free, which can make a really big difference in how much you have to live on in retirement. They also let you lock in your current tax rate, as opposed to being charged a potentially higher one that you could encounter later in life as you amass more income and wealth.

Naturally, there are other pros and cons to consider before making a decision on whether to invest in a Roth. Perhaps the most important factor is timing. Get it right and you’ll be able to fully maximize the tax benefits of a Roth IRA. Get it wrong and you probably would have been better off going with another retirement account.

Key Takeaways

  • The amount of tax that you pay on Roth contributions depends on how much you earn, so it’s wise to invest in one when you’re making less money.
  • The three times that are generally recommended are when you’re young and at the beginning of your career, when your income dips, and before income tax rates increase.
  • Using annual allowances as early as possible gives your money more time to grow in value.
  • Spreading out payments, the only option for many people, also isn’t a bad strategy—it lets you take advantage of dollar-cost averaging.

When Is the Best Time to Invest In a Roth IRA?

Paying tax now rather than later generally means that converting to a Roth IRA is favorable during periods when we earn less or when federal income tax rates are lower than normal.

Of course, nobody knows precisely what federal income tax rates will be like in the future, nor can they guarantee that they’ll be earning much more income then. The general consensus among most financial experts is that both are likely to happen, so your retirement will benefit from investing whatever funds you can put aside in a Roth IRA sooner rather than later. While it’s hard to argue with that logic, each case is different, and it’s up to you to make the final call based on your own particular circumstances.

The Sooner, the Better

The amount of tax that you pay on Roth contributions depends on how much you earn, so it’s wise to invest in one when you are making less money and in a lower tax bracket. Salaries and income usually go up gradually as you get older, which provides an incentive to front-load your tax burden. What’s more, there are income limitations to being able to invest in a Roth.

Another advantage of starting now is that it’ll give you more time to benefit from compounding, which is the process of an asset’s earnings, from either capital gains or interest, being reinvested to generate additional earnings over time. Compounding can accelerate the growth of your savings significantly, and with a Roth, all of these earnings are effectively tax free, provided that you play by the rules.

One of the main questions to ask yourself is whether you think you’ll be in a higher tax bracket when you retire than the one you are in today. If the answer is yes, then a Roth IRA probably is a smart option.

Convert When Income Dips

There is an annual limit to how much you can contribute to a Roth IRA—in 2022, it’s $6,000 ($7,000 if you’re age 50 or older). However, there are no limits when converting money to a Roth from a traditional IRA or some other retirement account, such as a 401(k).

If you’re thinking about doing a conversion, getting the timing right could save you thousands of dollars. Ideally, the best time to do this is when you experience a dip in income.

When you lose a job and are struggling financially, the last thing you’ll probably be thinking about is retirement. However, it can pay to do so. These periods can be a good time for taking stock of your finances and assessing any benefits for which you may be eligible.

If you have lots tucked away in tax-deferred savings, it probably isn’t wise to convert everything all at once, as this could push some of your income into a higher marginal tax bracket and result in a bigger tax bill, among other things. In this case, a smart move could be to stretch transfers out over several years. If in doubt, contact a tax advisor.

When Federal Income Tax Rates Are Favorable

The current tax rates, introduced with the Tax Cuts and Jobs Act (TCJA) of 2017, are set to expire in 2025—meaning that they will revert to higher rates—unless Congress extends them. It’s anyone’s guess what Washington will do next. What we do know, however, is that today’s income taxes are fairly low compared with the past, and there is a lot of public spending in the pipeline that will need funding.

When Is It Best to Make Annual Roth IRA Contributions? 

As already mentioned, there is a limit each year to how much you can contribute to your Roth IRA. The time frame to hit this quota isn’t the calendar year but rather up until the tax deadline—usually April 15—of the following year, barring any one-off exceptions. For the 2021 tax year, the deadline for Roth IRA contributions is April 18, 2022, for most states (extended due to the Emancipation Day holiday) but April 19 for Massachusetts and Maine (due to their observance of Patriots’ Day).

Is there a best moment to make your annual contributions? That depends on your personal circumstances and cash flow.

Immediately

If you have $6,000 or $7,000 lying around at the beginning of the year that you don’t need to pay bills and stay afloat, consider putting it in your Roth IRA straightaway. The logic here is that the sooner you contribute your money, the sooner it will start growing tax free.

Waiting until the deadline can lead you to miss out on around a year’s worth of stock market growth. Nine times out of 10, that growth will be significantly more than what you would generate from leaving the money in a regular checking or savings account.

One compelling reason to wait until just before the deadline is that by then, you should know your total income for the year—and, as a result, your marginal tax bracket. 

Spread Out

Of course, not everyone is fortunate enough to be sitting on $6,000 or $7,000 of nonessential money at the beginning of the year. Making a big lump-sum contribution isn’t always an option, and spreading out contributions is sometimes the only feasible way to add funds to a Roth IRA.

Drip-feeding money into a Roth does actually come with benefits:

  • It enables you to capitalize on dollar-cost averaging. Company shares and other investments have a tendency to fluctuate in valuation.
  • By investing each month, rather than in one lump sum, you are protecting yourself against price volatility. This could be particularly favorable if the price of the asset declines from the time when you would have made a lump-sum investment.

What is the downside of a Roth individual retirement account (Roth IRA)?

Like any financial product, Roth individual retirement accounts (Roth IRAs) are not completely flawless. Drawbacks of these retirement accounts include contributions being nondeductible, early withdrawal penalties on earnings, income eligibility restrictions, and limited investment choice.

How much should I put in my Roth IRA monthly?

You can fully fund your Roth IRA for the year with ​$500​ per month if you’re under age 50, or about $583 a month if you’re not. Maxing out contributions will ensure that you enjoy a more comfortable retirement. While you can always withdraw previous contributions without penalties if you find yourself in a tight spot, it’s generally better to avoid touching the money that you’ve invested.

What is the five-year rule for Roth IRAs?

The five-year rule mainly concerns the withdrawal of funds. In the case of a Roth, you can always withdraw contributions with no penalty at any age. However, to withdraw earnings without penalties, at least five years must have passed since you first contributed to the account, and you also must be at least 59½ years old.

The Bottom Line

If you are one of the growing number of people sold on the benefits of converting to a Roth, you should think carefully about getting the timing right. People love Roths because of their tax advantages, and those advantages can be enhanced by picking the right moment.

Generally speaking, younger people at the beginning of their careers could greatly benefit from investing straightaway in a Roth while their incomes are low. For older people looking to convert their tax-deferred savings to a Roth, it usually pays to strike whenever you make less money or before federal income tax rates increase.

Article Sources
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  2. Internal Revenue Service. “Roth Comparison Chart.”

  3. Internal Revenue Service. “Publication 590-A (2021), Contributions to Individual Retirement Arrangements (IRAs).”

  4. Internal Revenue Service. “Publication 590-B (2020), Distributions from Individual Retirement Arrangements (IRAs).”

  5. Internal Revenue Service. “Retirement Topics — IRA Contribution Limits.”

  6. Tax Policy Center. “The Effect of the TCJA Individual Income Tax Provisions Across Income Groups and Across the States.”

  7. Tax Foundation. “Historical U.S. Federal Individual Income Tax Rates & Brackets, 1862–2021.”

  8. Internal Revenue Service. “2022 Tax Filing Season Begins Jan. 24; IRS Outlines Refund Timing and What to Expect in Advance of April 18 Tax Deadline.”

  9. Internal Revenue Service. “Amount of Roth IRA Contributions That You Can Make for 2022.”

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