This Might Be the Biggest IRA Mistake You Can Make

Many retirees consider their IRA an essential part of their retirement plan. But despite their reliance on it, they don't always understand how it works. In fact, a common mistake in using one prevents investors from getting the most from this tool, even leaving them with much less to live on in retirement than they could have had.

You can fix a bad investment choice, but this one mistake can't be undone. Learn what it is and how you can pre-empt it, so you have a better chance of reaching the retirement you imagined.

The big mistake is lost time

If you thought the most popular error was in picking the wrong stock or fund, guess again. It's not investing early enough.

The time in the market matters more than trying to optimize funds later. Money you never put into your accounts doesn't have the power of compound growth. Those are years lost that you can never get back, and that's why it's smart to invest even small amounts earlier in your lifetime.

What time gives you back

Anyone familiar with finance knows the magic of compounding, and it works the same for IRAs as it does for savings accounts and other wealth-building tools. When your money earns returns, those returns earn returns, and so on. So, the longer money stays invested, the more you make, even without adding another dime to the bucket.

A small contribution in your 20s can end up beating a much larger investment farther down the road. To see this powerful feature in action, refer to a compound-interest calculator, available on most banking or finance websites.

Time helps you beat the limits

Another reason time matters is that you're limited to annual contribution limits in any given year. Even if you wanted to play catch-up in your 40s or 50s, you have to stay under the IRS limits. Just because you have $20,000 to throw into a fund doesn't mean you can.

Starting early helps you work around those limits by spreading that amount out over several years. It also helps you develop healthy saving habits that will benefit you throughout your lifetime.

The math in action

Here's one example of how a 20-year delay in contributing to a Roth IRA could affect your long-term balance, assuming a 7% average annual return for both savers.

In this example, one person starts investing at 25 and contributes just $3,500 a year. By age 65, they would have had $698,723.

Another person delays investing until age 45. Even if they contribute the annual IRS maximum each year, they could end up with about $307,466 by age 65.

The later saver has to contribute much more aggressively to catch up, at a time when they may be paying off a mortgage, putting kids through college, or caring for an aging parent. And still, they don't have nearly the amount put away at 65. Early savers gain a meaningful advantage in this comparison.

Why starting early matters

Many people treat setting up and making that first contribution as a single, dramatic event. Yes, you have annual contribution limits, and it can be daunting to think of putting away $7,500 a year. Instead, it should be considered a tiny, repeating habit that can be made with just $30 a month.

When you automate it as small chunks from your paycheck instead of a bill that's due each year, it's easier to manage and commit to. Motivation can be part of the problem, but it's more often about procrastinating things we perceive as difficult or not focusing on the right things. Automating gives us tiny wins that build habits but also don't require repeated decisions in our already distracted brains. You can always increase to meet the annual limits when you're comfortable.

How to free up cash

If you're concerned about a tight budget as the excuse for not starting, think about ways to free up just a little more cash. Trim dining out just one time this month or redirect a small recurring expense (like a streaming subscription) to your IRA instead.

You may not even have to cut anything. Go through your budget and weigh every transaction. Whether it's that monthly makeup box or an annual credit card membership fee, you may find you're paying for one or two things you weren't aware of.

Bottom line

The thought of a $300,000 IRA may seem unrealistic, but even big balances started with small steps. Once you commit to putting money away, you're more likely to continue even as your financial goals and earnings change. That's how you avoid one of the more costly financial mistakes.

You can choose between a traditional or Roth IRA, as each has its own tax benefits. Just remember that whatever you pick, you can always refine your strategy later. If you're putting away cash now, you're winning.

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Author Details

Chris Lewis, CEPF

Chris Lewis has spent his career turning data into answers. As the Head of Research at FinanceBuzz and a Certified Educator in Personal Finance, he oversees the data journalism and media relations teams, digging into the personal finance topics that shape Americans' lives at every stage, from Social Security and retirement income to 401(k) strategies, jobs, and real estate.