October 12, 2010

The 2014 contribution limit for a Roth IRA is $5,500 for normal contributions, and $1,000 additional contribution as a catch up if you are over age 50. In 2015 those limits will be adjusted for inflation, but those limits haven’t been announced yet. Assuming you’re under the age of 50 and looking to invest $5,500 in your Roth, how often should you contribute the funds? What sort of schedule should you have for your contributions? Should your contribution schedule be different if you just start investing today than if you have been investing for a while? Let’s take a look.

Set Your Roth IRA Contribution Schedule

Don’t trust yourself to simply remember to invest every so often in your Roth IRA. Inevitably life will get in the way and you’ll end up forgetting. Even though you technically have until April of the following tax year (for example, April 2015 for 2014 Roth IRAs) don’t leave your retirement fate in the hands of your always busy brain. Make it automatic.

Putting your contributions on an automatic schedule is one of the easiest ways to insure you fund your Roth IRA to the maximum allowable contribution limit every year. But how often should you contribute? Daily? Monthly? Every two weeks? One massive payment every year?

Let’s scratch that first one off the list immediately. Sending in a massive $5,000 contribution in once per year isn’t a good move. I won’t say you shouldn’t do it — at least you’re contributing — but that’s the worst way to contribute. Why? There’s a multitude of things that can go wrong. You might forget and go past the contribution date. That would be $5,000 you would never be able to put into a Roth. Also, assuming you invest your contributions immediately (rather than letting the cash just sit in the account), you will miss dollar cost averaging. The best method is some sort of automatic schedule tied to dollar cost averaging.

What is Dollar Cost Averaging?

Some people swear by it, others think it is no big deal. But dollar cost averaging is the process of spreading out your investment throughout a specific time period. In our scenario, a year. With dollar cost averaging you’ll end up investing in the stock or bond mutual funds at their average price over the year. You won’t be stuck by potentially investing at the absolute highest point of the market. You’ll also miss out on some potential benefit if you were able to invest all of your funds at the absolute lowest point in the market that year. At the end of the day this is a good idea. You and I don’t know what the high will be this year. We don’t know what the low will be. You should embrace being average in this case. So how do I accomplish this in my Roth IRA?

Instead of dumping $5,000 into your Roth IRA on January 1st, it would be better to spread that investment out over 12 months.  Just divide the amount you plan to contribute ($5,000) by 12 months. The result is $416.67. Now you ask your Roth IRA provider to kindly take that amount out of your attached checking or savings account every month. You’ll build up your balance throughout the year rather than all at once. Just make sure you have enough funds in your attached account on the days that the provider pulls the funds out. You don’t want to run into overdraft problems by trying to be smart with your retirement funds!

Alternative Investment Schedules

I personally use monthly payments to fund my Roth IRA. It just makes sense. Nice, even, monthly payments. However you could also consider every-other month, every quarter, or even semi-annual contributions. Setting up some sort of schedule is better than not scheduling anything.