The most common IRA mistakes made in retirement are easy to avoid. While it’s true that the rules surrounding Individual Retirement Accounts (IRAs) are complex, most IRA mistakes come from not asking the right questions or from trying to game the rules to avoid paying taxes.
As tempting as it might be to try and avoid paying taxes on retirement savings distributions, breaking the rules can be very expensive. In extreme cases, the IRS can even determine that your retirement account was never legal and charge you back taxes (and fines and penalties) on all your prior contributions from the time they were made. Clearly that’s not the kind of thing you want to happen.
Below are five key mistakes people make, and how to avoid them.
Many employers hire investment companies like Fidelity or Lincoln to administer their company retirement plans. When it’s time to leave the company plan, financial advisors often recommend doing a “rollover” – moving your funds from the company plan to your own IRA. When done properly, this isn’t a taxable event; the funds move from one plan to another. One frequent mistake in filling out the paperwork is accidentally checking the box to have taxes withheld. This creates a distribution from the plan which counts as taxable income, even though the money went directly to the IRS!
Playing with the 60-day rule
The 60-day rule is intended to make it easier to get a check from one custodian and deposit it into another. It allows you to temporarily withdraw funds from an IRA and if you put them back into an IRA within 60 days, the distribution won’t be taxable. If the funds aren’t deposited in an IRA within that 60-day window, that distribution is fully taxable. And you’re only allowed to do this once a year.
The mistake people make is using a 60-day rollover as a loan and then failing to get the funds back into the account on time. This can be an expensive mistake, so you should look for less risky alternatives. For example, the cost of borrowing from a Home Equity Line of Credit will likely be cheaper than the taxes (and possible penalties) on an unplanned IRA distribution.
Required Minimum Distributions (RMDs)
Once you reach 70½ you are required to start taking money out of your retirement accounts. There are different rules for different plans like IRAs, 401(k)s and 403(b)s. Inherited IRAs also typically have mandatory distributions. The rules are complex and easy to get wrong, especially if you have multiple accounts from several past employers. If you don’t take the minimum required distribution, the penalty is 50% of what you should have taken out. Consolidating your accounts is your best strategy to avoiding the pitfalls- it will make figuring out the required distributions much easier.
Not doing tax planning
The years between going into retirement and reaching age 70½ (when you start having taxable required minimum distributions from retirement accounts and IRAs) offer a prime opportunity to manage your current and future taxes. Tax planning moves such as Roth IRA conversions can help reduce future taxes, especially if you will have large RMDs later. And by making use of tax deductions to reduce your reportable income, you can shelter some or even all of these conversions from current taxes as well.
Not keeping your beneficiaries up to date
Beneficiary forms (not your will or trust) determine who receives your IRA or 401(k) after you die. If you get divorced but forget to make that change, your ex can inherit everything. When a person is named as an IRA beneficiary, he or she may be able to distribute the funds over their full lifetime, ‘stretching out’ the distributions and often reducing taxes paid. Most trusts, estates and other entities must distribute the funds within 5 years, often resulting in higher taxes.
Find experts you can trust
Avoiding IRA mistakes is one of the key benefits of working with a professional financial advisor. A good fee-only Certified Financial Planner® professional will know and understand all your retirement and IRA accounts, work with the respective account custodians, and coordinate with your tax preparer so that no mistakes happen.
At Blankinship & Foster, we work with you to build a coordinated retirement distribution plan. With a sound plan in place, you will avoid pitfalls and mistakes, and secure a worry-free retirement for many years to come. Contact us to learn more about our “Get To How” financial planning for retirees and pre-retirees.