Common IRA Mistakes in Retirement and How to Avoid Them

| November 5, 2018 | 0 Comments

The most common IRA mistakes made in retirement are easy to avoid. Most come from not understanding the complex rules surrounding Individual Retirement Accounts (IRAs). Others come from trying to game those rules to avoid paying taxes. As tempting as it might be to try to avoid paying taxes on retirement savings distributions, breaking the rules can be very expensive. In extreme cases, the IRS can determine that your retirement account was never really legal, and assess back taxes (and fines and penalties) on all of your prior contributions from the time they were made.

Below are five common IRA mistakes people make, and how to avoid them.

Rollover accidents.
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 it all 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 this as a 60-day loan and not getting the funds back into the account on time. Don’t do it. A Home Equity Line of Credit is 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 a required distribution, the penalty is 50% of what you should have taken out. Working with a fee-only financial planner to consolidate your accounts and figure out the required distributions is your best strategy to avoiding the pitfalls.

Not doing tax planning
The years between retirement and 70½ offer a prime opportunity to manage both your current and future taxes. For one thing, it’s a great time to do Roth IRA conversions, especially if you expect large RMDs later on. You can use your deductions that get you down to little or no reportable income to shelter these conversions.

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. Find a fee-only Certified Financial Planner® professional (who isn’t compensated based on commissions) to help you prepare for retirement and help you avoid these and other traps.

This column is prepared by Rick Brooks, CFA®, CFP®. Brooks is director/Investment Management with Blankinship & Foster, LLC, a wealth advisory firm specializing in financial planning and investment management for people preparing for retirement. Brooks can be reached at (858) 755-5166, or by email at Brooks and his family live in Mission Hills.


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