Contributing to your IRA is something to feel proud of. Whether you sock away a bit of money regularly, or make one big contribution around tax time, it's great to keep putting money away for your future.
But there's an extra step with these accounts that too many people miss: If you don't designate the way to invest the money you contribute, it just sits in cash, week after week, not earning very much.
"Some people contribute for years but never invest the money," says Brittney Hopkins, an associate at Fidelity. Hopkins' job is to help people understand their finances better and figure out the next steps they should take.
In many cases, savers contribute to IRAs regularly but don't realize that these accounts work differently than workplace 401(k) plans, in which money may be invested according to a plan's qualified default investment alternative.
Despite many reminders and prompts, people often miss this step. Here's what you need to know.
1. Congratulate yourself
Contributing is a great step: The key to long-term savings is simply to get started. Dates like the annual tax return filing deadline can be a good way to motivate yourself to save.
"There are some who will set up automatic transfers throughout the year, but most people just put in one amount, usually around April, for the year," says Andrew Jacob, a representative at Fidelity.
Consider this: If you're age 25 and invest $6,000, the maximum annual IRA contribution in 2022, that one contribution could grow to $89,847 after 40 years. If you're age 50 or older, you can contribute $7,000, which could grow to about $19,313 in 15 years.1 If you keep contributing yearly, your potential for growth could increase. (We used a 7% long-term compounded annual hypothetical rate of return and assumed the money stays invested the entire time.)
Tip: Read more about saving for retirement.
This hypothetical example assumes the following: pre-tax contributions of $6,000 once a year until age 50, and then $7,000 until age 67 and an annual rate of return of 7%.2
2. Put your money to work
One reason many people miss the step of investing their contributions could be because they think the IRA itself is the investment. "It's an assumption people have," says Rodel Catahan, another Fidelity associate. "They ask questions like: How much does an IRA earn?"
The IRA is just the holder account where you put your contributions, but you have more options than just cash, including exchange-traded funds (ETFs), mutual funds, individual securities, and CDs. The process of investing the money can potentially be as easy as a few clicks, once you know what you want to do with it.
But a hurdle for many people is that the thousands of choices for funds can be overwhelming, and people get afraid of making the wrong decision, coaches say. If you have decision overload, there are lots of resources available for sorting through your choices, including our guide to investing ideas for your IRA and managed accounts.
This is how it can work out if you stick with it: One man Hopkins worked with had not invested his IRA contributions for nearly 10 years. After he started working with Hopkins, they developed a plan to put his $10,000 nest egg into a target-date fund. These types of funds invest based on their anticipated year of retirement. You don't need to adjust your asset allocation over time because the funds become more conservative the closer they get to their target retirement date. He's now in his 50s, so he'll have time before retirement to grow his assets.
Tip: Build your knowledge with our investing learning path.
This hypothetical example assumes the following 2 scenarios with an annual rate of return of 7% for both: an initial investment of $10,000 after 15 years, or an initial investment of $10,000, plus additional catch-up contributions of $7,000 per year for those 15 years.2
3. Don't worry that it's too late
Often, the people who don't invest their IRA contributions notice the oversight when they are doing some other financial task. They will notice that the account they thought was invested for their goals and time horizon has been stalled while their other invested accounts may have grown significantly. They might also be prompted by an email or a representative.
One woman that Fidelity associate Ty Woodruff spoke to realized when she was settling her late husband's accounts that the IRA he left her had never been invested, and had $200,000 sitting in cash. "But it's never too late," says Woodruff. "I got her connected with the resources she needed, and she put together a plan to invest the money."
This hypothetical example assumes the following: an initial investment of $200,000 and an annual rate of return of 7%.2
The key is not to give up. "At first, my clients may be upset or frustrated, but then they are appreciative when they get themselves back on track," says Woodruff.
Tip: Read more about planning strategies.