Can you amass $1 million in retirement savings with just an IRA? You may be skeptical, but the answer is yes. The real question is how long would it take?
XSaving $1 million is totally doable. And success does not depend on unrealistic assumptions.
Did you just raise your eyebrows? Perhaps you're thinking it's hard enough to save $1 million in, say, a 401(k) account, where the $19,500 basic annual contribution limit is more than triple your IRA's $6,000 contribution cap this year.
The maximum additional amount you can contribute to your 401(k) if you are age 50 or older is much higher too: $6,500 vs. $1,000.
Retirement Savings: Building A $1 Million IRA Balance
And in your 401(k) account, you almost certainly receive contributions from your employer as well. Employers don't kick into traditional IRAs, though.
For a rundown of annual contribution limits for 401(k)s and IRAs as well as rules about how much you're allowed to deduct on your tax returns, read these other IBD reports.
With a Roth IRA, some different rules apply. You're not allowed to open or contribute to a Roth IRA if you make too much money.
But don't worry. You can still make sure that money ends up in a Roth IRA, where all withdrawals after age 59-1/2 and five years are tax-free. Start by contributing money to a nondeductible traditional IRA. Then convert that money to a Roth IRA. Just remember, if you have other traditional IRAs, part of that conversion could be taxable.
How To Save $1 Million
Now let's get back to the central question: Can you build up at least a $1 million balance in your traditional IRA?
Let's say you kick in $6,000, the basic maximum you're allowed to ante up this year. Let's also say you are a 25-year-old, just starting your career.
And for the sake of discussion, let's assume you plan to retire at age 67. Why that age? Because Congress will probably trim benefits for people who retire at 65 instead of 67, to prop up the Social Security system's finances. Even now, you get a bigger benefit by waiting until age 70.
Next, let's say your income now is $70,000. That puts you into the 22% marginal tax bracket. Today, that bracket starts with income above $40,525. So let's agree that you'll also be in the 22% bracket at retirement.
And let's say the annual rate of inflation is 1%.
How Fast Will Your Retirement Savings Grow?
Finally, suppose you've invested your IRA in mutual funds whose annual return between now and retirement averages 7%.
That's a reasonable assumption. It might even be a little conservative. That's because large-cap stocks like the S&P 500 averaged a gain over 10% since the start of 1926 through this past Nov. 30, according to Morningstar Direct. Small-cap stocks grew at an average of nearly 12% a year.
In later years, you may add bonds to dampen volatility and enhance yield. Even a popular index of corporate bonds averaged more than 6% growth.
So all in all, your overall assumption of a long-term 7% a year average gain is totally likely.
Crunching Your Retirement Savings Numbers
What happens? First, look at how your retirement savings grow with a traditional, Simple or SEP IRA. At age 67, your ending balance is $1.38 million. If you withdrew the whole balance at once, you'd still have a nest egg worth $1.08 million after paying income tax. And you'd almost certainly not withdraw the entire balance at once. Instead, you'd likely take out only as much as you need each year. You'd leave the rest inside your IRA. There, it would continue to grow, sheltered from current income taxes.
If you put the money into a Roth IRA, at age 67 you'd have $1.08 million both before and after taxes. That's because withdrawals from a Roth IRA are tax-free in this situation.
If you had saved the money in a regular, taxable savings account or taxable brokerage account instead of using an IRA? Your age-67 balance would be $713,640.
Save As Much As You Can
Look again at that $1.38 million age-67 balance we spoke about. How important is it to save as much as you can? That balance would be built with annual contributions of $6,000. If you kicked in only $5,000 a year, your age-67 balance would be merely $879,753.
Don't Forget Catch-Up Contributions
So far, the retirement savings figures we're showing you do not include any so-called makeup contributions. That's the extra money you're allowed to kick in starting at age 50. And they don't include cost-of-living adjustments to the contribution caps. When inflation rises enough, the IRS raises the contribution caps.
What happens if you do add $1,000 in catch-up contributions to your basic $6,000 contribution? By age 67, your balance would be $1.5 million, according to calculator.net. After income taxes, you'd still have nearly $1.2 million.
Start Saving Early
What happens if you start the whole retirement savings process 10 years later at age 35? That 10-year delay would cost you a ton of money. Your traditional IRA balance at age 67 would be $661,309.
After paying income taxes, your balance would be just $515,821.
If you start to add catch-up contributions at 50, your age-67 balance would still be only $744,440. After taxes, you'd have $580,663 left.
Retirement Savings Lessons
What lessons can you take away from all of this?
First, you can build retirement savings that exceed $1 million with an IRA. "It is doable," said Ed Slott, founder of IRAHelp.com. "Numbers don't lie."
Second, the earlier you start, the easier it will be. "The sooner you start to save, the more time your savings have to grow through compounding," Slott said.
Third, do not overlook catch-up contributions. "Most people are not making catch-up contributions, and it's a big missed opportunity," Slott said. "You should make catch-up contributions if you're eligible."
Follow Paul Katzeff on Twitter at @IBD_PKatzeff for tips about retirement planning and active mutual fund managers who consistently outperform the market.
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