(Legally) add more than $5,500 to your Roth IRA each year

I add $6735 in cash to my Roth IRA each year. Those of you over 50 may already be “catching up” by adding $6500 a year. However, I am only 31.

How am I able to add more than the IRS-mandated $5500 a year and keep it all tax free?

Before I explain, let me go through a scenario comparing the power of contributing more each year.

This assumes an annual 7% growth of your Roth IRA held investments. Some years will be more and some less, but overall we’ll say the market will return about that amount.

If you contribute $5,500 a year you’ll end up with an account worth $33,843 in 5 years, $81,310 in 10 years, $241,258 in 20 years, and $555,901 in 30 years.

If you contribute $6,735 a year you’ll end up with an account worth $41,442 in 5 years, $99,568 in 10 years, $295,432 in 20 years, and $680,727 in 30 years (I’d be 61).

After 30 years, the larger contribution each year would result in an account worth $124,826 more! That’s not an insignificant amount of change.

And what if I told you that by using this method I could actually add even more?! $6797 in year 2 and $6862 in year 3? In fact, I’m pretty comfortable making the claim that 10 years from now I’ll be contributing at least $7500 a year into my Roth IRA. And that amount will only go up in the future!

Here’s the secret to make this legal: Invest in dividend paying stocks.

My Roth IRA has a yield of just under 3.5% right now. Historically the dividends have increased at a rate of greater than 5% per year. I take 100% of the cash coming in as dividends and reinvest it. This allows the compounding to work on increasingly larger amounts of money each quarter. And these dividends and capital gains are all tax free!

My Roth currently has a value of $35,570. That amount was reached by about 6 years of $5,500 (initially $5000) annual contributions of post-tax money, dividend reinvestment, and capital gains.

It would take you about 5-6 years to get to the point where I am now, provided you have no retirement account.

However, the sooner you open a Roth, the better. It wouldn’t take long before you could add more cash into your Roth than the IRS usually allows. If you just opened your Roth IRA for tax year 2014 and added the maximum of $5,500, you could anticipate adding an additional $193 in cash to the account in dividends over the next year (assuming 3.5% yield).

Why not start planning for your future retirement today?

How much above the IRS contribution limit are you adding to your retirement account?

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4 Responses

  1. Hi, Two Investing.
    Thanks for the post. I’m a big fan of the Roth IRA and aim to invest the full amount each year as close to Jan 1st as possible. While I love dividend growth stocks, I still manage to sneak a few high growth names into my Roth as well. Often times I will supplement these purchases with covered calls in order to generate some additional income. I still stumble here and there, but I definitely attempt to learn from my mistakes. Happy Thanksgiving!

    Goosemann Jones
    Flight to Dividends Blog
    Goosemann Jones recently posted…Portfolio Overview-Traditional IRAMy Profile

    • scott says:

      Hi Goosemann Jones,

      Especially when you’re young, high growth companies are great things to put into a Roth vehicle. It will be great in the future to have all that huge capital gain and not owe a dime to the government. (That is provided that they don’t vote to change the terms of the Roth respectively in the future! See what happened in Cyprus a few years ago.)

      I’ll have to look into selling some covered calls on a few of my Roth IRA stocks as well. The few I did it for (CSCO and KMI) worked out well. However, my commissions at Schwab are a little high for the amount of profits I’d take in by selling only a single contract. I’m thinking about asking Schwab if I can get the rates I get at TD Ameritrade, which are $1.50 per contract.

      Have a great Thanksgiving too!

  2. DivHut says:

    Just another example of the power of dividends and compounding time. I only opened a ROTH account in recent years and wish I had done it at the same time I started with my brokerage account. There’s no denying the power of tax free dividend income compounded over decades. It really does make a huge difference.
    DivHut recently posted…Recent Stock Purchase II – November 2014My Profile

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