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Mistake No. 1: Living only for today IRAs, or individual retirement accounts, may be trickier than you think. And what you don't know could cost you money.
Many of the most common IRA mistakes happen just because people aren’t aware of the rules governing these accounts -- of which there are many. Complex rules provide many chances for things to go awry, but the biggest mistake with IRAs may be not having one at all.
"If you don't put anything in, you won't have anything at the end," says IRA expert Ed Slott, president of Ed Slott and Co., and author of "The Retirement Savings Time Bomb … and How to Defuse It."
Each year that you're eligible to make contributions to an IRA and fail to is a chunk of retirement income lost. The most important factor in the amount of money accumulated at retirement is the amount you save, not the rate of return on investments.
general, "If you run the numbers, someone who doesn't skip contribution
years versus someone who does, the person who doesn't skip years will
end up with more money in retirement," says Ken Hevert, vice president
of retirement products at Fidelity Investments.
Mistake No. 2: Missing tax-free growth The most common types of IRAs are the Roth and the traditional IRA. Both
accounts allow annual contributions of up to $5,000, but they receive
different tax treatment. In short, Roth IRA contributions are made with
after-tax money, while contributions to a traditional IRA may be
eligible for a tax deduction for the year the investment was made.
the Roth, taxes are paid on the front end so that in retirement all
distributions, including interest and earnings, are tax-free.
Conversely, the traditional IRA generally gets a tax advantage at the
time the contribution is made, but withdrawals are taxed as ordinary
income in retirement.
There is an exception to that rule,
however. High earners who are covered by a retirement plan at work may
not qualify for a tax deduction. Big moneymakers are restricted on the Roth side too.
limits keep high earners from contributing directly to a Roth. A
married couple who files taxes jointly and earns more than $183,000 per
year cannot contribute to a Roth, and single people earning more than
$125,000 are also prohibited.
But all is not lost. Keep reading to see how to avoid these apparent obstacles to IRA investing.
Mistake No. 3: Lost opportunity due to ignorance Make too much money to contribute to an IRA? You can get around this problem.
earners can still take advantage of the Roth IRA by contributing to a
nondeductible IRA and then converting to a Roth. A nondeductible IRA is
simply a traditional IRA for which there is no tax deduction, and it is
available to almost everyone with wages or self-employment income.
do that myself. I make too much to contribute to a Roth, so I can
contribute to a nondeductible IRA and convert it to a Roth," says Slott.
really just moving money from a taxable pocket to a tax-free pocket.
Why wouldn't everybody do it to shelter their money from future higher
taxes at no cost?" he says.
Mistake No. 4: Messing up RMDs IRS
rules call for required minimum distributions, or RMDs, from
traditional IRAs beginning at age 70½. Failing to take the entire amount
required can lead to harsh penalties.
"The IRS can charge a tax
penalty of up to 50 percent of the distribution. So it could be quite
severe," says Evan Shorten, CFP, president of Paragon Financial Partners
in Los Angeles.
With a Roth IRA, no minimum distributions are
required during your lifetime. If you pass away and leave the Roth to a
nonspouse beneficiary, that person will be required to take
distributions based on their own life expectancy if they choose to
stretch the tax advantage of the retirement account until the end of
their own life.
Beneficiaries of traditional IRAs who choose the
stretch option are subject to the required minimum distribution rules as
well and face the same 50% penalty for failing to take the full
Mistake No. 5: Contributing too much The
IRS limits the amount that may be contributed to a Roth or traditional
IRA in any one year. For 2012, the contribution limit is $5,000. For
those 50 and older, the limit is $6,000.
With contribution limits
strictly enforced, putting in more than the allowed amount can trigger a
penalty -- to the tune of 6% on the excess each year. There are
several ways to make this mistake, not the least of which is simply
forgetting you made a contribution previously in the year.
contributions can occur by funding an IRA after age 70½, contributing
more than your taxable income for the year or contributing on behalf of a
"Some people may have gotten into the
routine of contributing to a personal and spousal IRA, and for whatever
reason, the spousal IRA continues after they're deceased," says
Luckily this mistake is easily fixed as long as you catch it before you file your taxes.
"Get it out before you file and no harm, no foul," Hevert says. "Another
(option) is to essentially carry that contribution to another year, and
have that count toward that tax year's contribution amount -- but you
have to document that with the IRS," he says.
Mistake No. 6: IRA rollovers gone wrong Unfortunately, paying someone to take care of your financial transactions is no guarantee of perfection.
"Advisers are generally not proactive, and they don't check things," Slott says.
transactions, such as transferring a retirement account, require
attention to detail. Whether you're rolling over a 401(k) or
transferring your IRA to a new custodian, not only do you need to pay
careful attention to those little check-boxes; the customer service
representative at the receiving institution also needs to be on alert.
see cases on this all the time. They find out the money never got to an
IRA, the broker or bank moved the money and hit the wrong box, and it
went to a regular account. That's a taxable distribution," says Slott.
the possibility of losing the tax shelter of the IRA as well as paying
the taxes owed on the entire account balance, an IRA owner has only one
way of fixing rollover mistakes like these.
"You have to go to
the IRS for relief, and that is going to be expensive and take six to
nine months to get a decision," Slott says.
Mistake No. 7: Blowing the deadline A
trustee-to-trustee rollover isn't the only option for moving between
retirement accounts. Individuals can take funds out of their IRAs or
take a distribution from their 401(k) when they leave an employer and
put it back into a qualified retirement account without tax penalties as
long as they do so within 60 days.
"That may seem like a long
time, but a lot of people blow it. And another thing: You can only do
that once every 365 days, not calendar year. Some people can lose their
entire IRA because they did two rollovers in a year and didn't realize
it," Slott says.
The surest bet is to do a direct transfer from
one institution to another. When everything goes correctly, the money
never comes out of a retirement account because the check is written to
the receiving institution, not an individual. In the end, however, the
burden is on the account owner to make sure their new account is set up
Mistake No. 8: Neglecting beneficiary forms Filling
out a beneficiary form correctly is a hassle. Personal information from
the beneficiaries is needed, including birth dates and Social Security
numbers. It's so easy to focus on just getting the account open and then
taking care of the beneficiaries later, someday – but don’t let
yourself! Do it right away!
"When you open an account or
transfer or convert, you need new beneficiary forms. Most don't check
those things because they think someone else did or it's in their will,"
Not having a beneficiary form won't affect you after
you pass on, obviously, but "your beneficiaries can lose valuable tax
benefits, they won't be able to stretch (distributions) over their
lifetime, so a lot of benefits can be lost -- or it can go to the wrong
person," Slott says.
As with many facets of these accounts,
failure to carefully check the details can come back to haunt you or
your loved ones. When in doubt, consult a professional. But don't be
afraid to double-check their work: it is your life savings, after all.