Over the years, we’ve received many questions regarding Individual Retirement Accounts (IRAs). Typically, most investors want to know if they should choose a Traditional IRA or a Roth IRA. However in reality, while there are differences as well as pros and cons for each, the key focus should be on avoiding the most common mistakes pertaining to IRAs in general.
Today, we’ll discuss five of the most common mistakes that we’ve seen.
#1 – Neglecting to Update Beneficiaries
Believe it or not, this is one of the most common mistakes individual investors make when it comes to managing their IRA, said Al Meadows, MBA, CFP® and Wealth Advisor with Gratus Capital.
“If you haven’t assigned a beneficiary for your IRA and do not have a will or trust established when you die, then the distribution of your IRA proceeds will be determined by the probate court,” said Meadows. “Also, many people are surprised to find out that beneficiary designations will override provisions in a will or trust agreement. Unfortunately, I’ve heard of situations where someone’s hard-earned money went to someone they didn’t want it to go to, such as an ex-spouse still listed as the beneficiary.”
Meadows recommends revisiting your beneficiary designations for all of your investment accounts no less than once a year. He adds that it’s particularly important to update your beneficiaries when there is a significant change in your life, e.g., divorce, death of a loved one, purchase or sale of a business, etc.
#2 – Roll-Over Mishaps
One of the key reasons an investor transfers their IRA savings is due to a change in employers. In general, as long as you’re transferring your IRA retirement savings as a “directed distribution,” meaning from one trustee to another, you don’t need to worry about unplanned taxes or early withdrawal penalties.
However, if you request a withdrawal in the form of a check or direct deposit, you have only 60 days to roll this money into an IRA in order to avoid an early withdrawal penalty and additional ordinary income taxes.
Furthermore, if you receive a direct withdrawal of your IRA funds, keep in mind that the trustee is required to withhold 20 percent of your total IRA balance. Why? Because the IRS assumes that you’re keeping the other 80 percent (not rolling it over into another IRA account) and, therefore, requires the trustee to facilitate the withholding of your savings in order to pay the income taxes on the 80 percent that you retained.
If you do decide to roll over your direct withdrawal of 80 percent into an IRA, you must then come up with the other 20 percent in order to avoid the above penalties. The trustee can’t distribute this money to you. Rather, it will be reflected as a credit on your next income tax return, said Meadows.
#3 – Forgetting about Required Minimum Distributions (RMDs)
According to the IRS[i], you can’t keep retirement funds in your account indefinitely. Generally, you have to start taking withdrawals from your IRA, SIMPLE IRA, SEP IRA or retirement plan account when you reach age 70-1/2. Roth IRAs do not require withdrawals until after the death of the owner.
To determine your required minimum distribution, the IRS provides several different worksheets[ii]. The IRS adds that you can withdraw more than the minimum required amount. Your withdrawals will be included in your taxable income, except for any part that was taxed previously or that can be received tax-free, such as qualified distributions from Roth accounts[iii].
“Sometimes investors forget that they have a small IRA tucked away somewhere,” said Meadows. “One time, when a new client came to me with 4+ million in assets, we discovered that he had a $100,000 IRA sitting in a self-directed account that he hadn’t touched in more than 20 years. Since he was retired, we quickly accounted for his minimum distribution so that he could avoid any further unnecessary penalties.”
#4 – Over-Contributing to an IRA
According to Meadows, there are limitations as to how much you can contribute to a Traditional or Roth IRA each tax year. Investors under age 50 may contribute up to $5,500 per year. Investors age 50 and older may contribute up to $6,500 each year. However, how much you can actually contribute is determined by your income. Also, tax deductions related to these contributions depend on whether or not you or your spouse are covered by an employer-sponsored retirement plan.
If you or your spouse are not covered by an employer-sponsored retirement plan, then refer to this chart to determine your tax deductions and income requirements. However, if you or your spouse do have an employer-sponsored retirement plan, then refer to this chart instead.[iv]
#5 – Mindset & Emotional Mistakes
There are a handful of other IRA mistakes that Meadows has seen over the years, including mindset or emotional mistakes.
- Not starting soon enough – It’s never too soon to start saving for retirement. The key is to open an account now and set up an automatic deposit.
- Not taking advantage of the “catch up” contribution – The IRS enables investors to contribute more to their IRAs when they reach age 50, up to $6,500. The extra $1,000 a year can truly make a difference for those reaching retirement said, Meadows.
- Stopping contributions – Some investors think they have enough money already, so they stop contributing to their IRA. With increasing longevity and inflation, there really isn’t much downside to continuing your contributions, said Meadows.
At Gratus Capital, we consider IRAs, 401(k)s and many other retirement savings vehicles to be key tools in building, diversifying and sustaining long-term wealth. We encourage all individual investors to contribute no less than the amount your employer matches, and ideally more. If you have questions about your retirement vehicles or other financial questions pertaining to financial, estate, insurance, tax and philanthropic planning or asset management, please contact us.
The above article is intended to provide generalized financial information; it does not give personalized tax, investment, legal, or other professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other matters that affect you or your business.