For retirement savers under 50, the maximum annual contribution to an individual retirement account in 2024 is $7,000. Investing that full amount can boost your long-term returns through compounding and tax benefits. However, there are many variables that make it difficult to calculate potential returns, including how well your investments perform within the IRA.
Before attempting to estimate how much a maximum IRA contribution could be worth in the long run, consider the following:
— What determines an IRA’s return?
— What investments can be held in an IRA?
— How does compounding grow an IRA’s return?
— How do tax benefits boost IRA growth?
— Should you max out an IRA for a better return?
What Determines an IRA’s Return?
An IRA is not an investment itself; instead, it’s a tax-advantaged account designed to help Americans save for retirement. That means the investments held inside an IRA will determine its return.
When using a diversified allocation of stocks, an investor may see an annual return of 7% to 10%, said Paul Miller, managing partner and certified public accountant at New York-based Miller & Company, in an email.
“It’s best to keep in mind, though, that this can fluctuate a lot depending on market conditions and the specific investments that are being held,” he said.
Since an IRA’s return is tied to the investments it holds, not the structure of the account itself, that means, for example, that a tilt toward equities will likely result in a higher return than an account with a greater fixed-income allocation.
“The other primary determinant of your IRA’s performance is you,” said Brian Lawrence, a chartered financial analyst at North Ridge Wealth Advisors in Beaverton, Oregon, in an email.
“The best investments in the world will do no good if you can’t stick with them through market downturns. Investors must stay invested. Hopping in and out of the market or investments due to fear or greed can lead to missing out on market recoveries or buying when markets are peaking,” Lawrence said.
[READ: IRA Versus 401(k): Which Is Better?]
What Investments Can Be Held in an IRA?
IRAs have an advantage over employer-sponsored 401(k)s. There are no restrictions on which publicly traded securities you can hold in an IRA.
That differs from a 401(k), where choices are limited to a list of mutual funds or exchange-traded funds, said Bobbi Rebell, a certified financial planner at CardRates.com in Gainesville, Florida, in an email.
“Because you can choose from a wide-ranging universe of investment products, including individual stocks, you can take more risk and potentially get a higher return,” Rebell said. “On the flip side, an investor who wants to minimize risk could put their assets into money market funds, which will provide safety and security but also a much lower return.”
[READ: Should Retirees Follow the 100-Minus-Your-Age Rule for Stock Allocation?]
How Does Compounding Grow an IRA’s Return?
A major benefit of remaining invested in an IRA or other investment account is compound returns.
Compounding happens when your investments generate earnings, which you then reinvest to generate even more earnings. Over time, this snowball effect accelerates growth, maximizing the long-term value of your retirement savings.
“Compound growth makes your investments grow much faster,” said Joel Callagan, certified financial planner and vice president at Wealth Enhancement Group in Los Angeles, in an email.
For example, Callagan said, if you have $100 invested in a stock that returns 5%, you can simply pocket that $5 every year.
However, if you reinvest the money into the stock, you’ll have $105 invested, making the 5% return $5.25.
“Compound interest is when the money your money made starts making money for you as well,” Callagan said. “That, combined with time, is the recipe for sustained growth.”
How Do Tax Benefits Boost IRA Growth?
There are two types of IRAs: traditional and Roth.
Both have tax advantages, although a traditional IRA offers tax-deferred growth with deductible contributions, while a Roth IRA is funded with after-tax dollars and provides tax-free withdrawals in retirement.
“Traditional IRAs offer a current-year tax advantage in that the money you contribute is not taxable that year. That can be very helpful in reducing the expense for high earners,” Callagan said.
When it comes to a Roth IRA’s tax-free withdrawals, Callagan said, “Not paying taxes on the compounded growth is a massive advantage because you can actually keep every dollar of your account.”
For both types of accounts, he said, the ability to rebalance investments without any tax implications boosts an account’s growth potential. It allows investors to buy low and sell high without worrying about the tax implications as long as the funds stay within the account.
[See: How to Reduce Your Tax Bill by Saving for Retirement.]
Should You Max out an IRA for a Better Return?
Investing the entire $7,000 that’s allowable can potentially help boost returns in the long run. The more you contribute, the more capital you have to invest. In addition, this larger pool of money can benefit from compounding growth, tax advantages and market gains over time.
However, the actual return still depends on the performance of the investments held within the IRA, what investments you’ve chosen and your ability to stick with your strategy even if the market declines.
“If you can afford to max out your IRA, it is usually a good idea because it will reduce your taxes that year,” Rebell said. “It is not necessarily tied to a better return in terms of the investments you make. In any given year, for example, your investment could go down in value.”
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