When $500 can actually be worth more than $500

Posted by on October 23, 2013 @ 10:30 am in Retirement

If you’re not a retirement savings “geek” like me, you may have missed the news that the IRS increased contribution limits for IRAs this year. It’s the first increase we’ve seen since 2008. In 2013, the limits increase to $5,500 if you’re under age 50 and $6,500 if you’re 50+—an increase of $500, which is a 10% increase.

At first blush, $500 may not seem like a material increase. Certainly many, including me, would like to see higher limits to encourage greater retirement savings. But even taking full advantage of this increase can, over time, make a rather significant difference in an IRA.

To demonstrate this point, take a look at this rather simplistic example. I assume that an investor contributes $500 to her IRA this year. To keep it simple, I assume that the account earns a 4% real return. At the end of 30 years, the account grows to $1,622 (in today’s dollars). Through the power of compounding, the $500 grew to over $1,600.

Compounding image

Source:  Vanguard.

Even though it’s a hypothetical example, it does drive home the message of compounding. I encourage you to take advantage of full IRA contributions every year, especially when made to a Roth under which earnings grow tax free. Greater savings today will enable you to reap greater financial rewards later in retirement.