People often make mistakes with their IRA’s. These mistakes often arise from the complexity of our laws pertaining to IRA’s. Here are some of the most common mistakes I have seen:
1) Not contributing enough or consistently enough – IRA’s are designed to help you save money for retirement. Depending on your income level, contributions to an IRA may be tax-deductible and your investments grow tax-deferred. Many people fail to take advantage of this advantage, by contributing less than the maximum allowed by law or by skipping a year in favor of other priorities. Contribution limits are set by law and have changed over the years while contribution limits to some IRA’s are adjusted for inflation every year.
2) Not converting your traditional IRA to a ROTH IRA – A traditional IRA contribution confers an immediate advantage. If you are eligible, you may be entitled to an income tax deduction for making a contribution to your IRA and you enjoy tax-deferred savings on the growth. With a ROTH IRA, you do not get a current year income tax deduction, but if you meet eligibility requirements, you can enjoy tax- free investment growth on the investments in your retirement fund. Depending on your situation, it may be better to convert your traditional IRA to a ROTH IRA. Many of us have not taken the time to revisit our old traditional IRA’s and evaluate if a ROTH IRA might be a better option. If you are uncertain, seek professional guidance; your retirement is too important to leave it to chance.
3) Not knowing the difference between the benefits of a 401(k) plan and an IRA – 401(k) plans are retirement plans sponsored by your employer. Many employers match employee contributions up to defined limits. If your employer matches your contributions, it makes sense to first maximize your savings in your 401(k) before contributing to your IRA. Otherwise, you could be leaving free money on the table.
4) Not taking advantage of catch-up contributions – In order to help people who have not contributed the maximum amount to IRA’s and other retirement plans, federal tax laws may permit you to make “catch-up” contributions. Many fail to take advantage of this opportunity. Making sure you understand and take full advantage of these catch-up provisions can help you build your retirement nest egg.
5) Not choosing your IRA beneficiaries wisely – This area is where I frequently see an opportunity to create value. Here are some of the most common mistakes I have seen:
- Not naming your beneficiaries to your IRA. Who should inherit your IRA? Our retirement accounts can account for a significant portion of our net worth; make sure you name appropriate beneficiaries for each account.
- Not periodically reviewing and updating your beneficiaries – You should periodically review and, if necessary, update the beneficiaries to your IRA and other retirement accounts. Life and circumstances change such as marriage, death or divorce of your spouse, children or other beneficiaries, or you may be able to fulfill some important estate planning needs by naming your estate as the beneficiary of your account.
- Not considering all your options – If you are the beneficiary of an estate or an IRA, how you convert or rollover may impact your tax liabilities. Not paying attention to these crucial details could increase income and estate tax liability. Improper conversions carry penalties as high as 50%.
While mistakes are common, in most cases making a change to your retirement plan beneficiaries is relatively simple. Consult your tax professional and your plan administrator to understand your options.
6) Not Taking Required Distributions and Miscalculating Distribution Amounts –Distributions from IRA’s or other retirement plans is the second most common area where people often make mistakes with their IRA’s, and it is no wonder : laws governing the timing and amount of mandatory distributions from your IRA can be quite perplexing. Moreover, the IRS can asses huge penalties and tax consequences if you fail to take a required distribution, miscalculate your distribution, take early distributions, or improperly roll over a 401(k) or other retirement plan. An improper rollover can result in the entire balance of that plan being deemed a distribution for tax purposes. If you are not sure, consult your financial advisor who should be able to assess your situation and address your concerns.
7) Not using a non-deductible IRA – When a taxpayer’s income exceeds certain limits, contributions to an IRA are no longer tax deductible. Many people fail to appreciate that it still may make sense to contribute to an IRA even if the contribution is not deductible. While you will not receive a tax benefit in the current tax year, your IRA investments will still enjoy tax-deferred growth. Over time, the benefit of tax-deferred growth can make a big difference to your retirement dollars. You may even be able to convert to a ROTH IRA on a later date.
Why do so many people rush to open an IRA in the next month or so to help with 2011 taxes?
Many people sit down to do their taxes and realize that they owe the IRS money. The deadline for IRA contributions for the 2011 tax year is not December 31, 2011; the federal government allows taxpayers additional time to contribute to their retirement plan, until April 15, 2012, or later if you have filed extensions . If you are eligible, you often can make a last-minute traditional IRA contribution. By contributing to your 2011 IRA, you could lower your taxes due even as your IRA contribution builds your retirement savings.
à Tip: If you have the financial flexibility to do so, make your IRA contribution as early as possible each year, January 1. By not waiting until tax time of the following year to contribute to your IRA or other retirement plan, you give your investments a year’s head start on earning tax-deferred growth.
What are a few important facts people should know about traditional IRAs so there are no surprises later?
When you are opening your IRA account or making a contribution to your retirement plan, ask yourself these questions:
1) What type of an IRA suits your needs – a traditional IRA or a ROTH IRA? For small business owners a SEP-IRA or a SIMPLE IRA may be better options. Have you considered these?
2) Have your maxed your 401(k) contributions, especially to take advantage of any employer match?
3) Have you named your beneficiaries to your IRA? Do you know who you have named as beneficiaries and do you need to update beneficiaries?
4) Depending on your income and current circumstances, you contribution limits for each year could be different. Are you contributing the maximum possible without exceeding the limits?
5) Have you attributed your IRA contribution to the correct tax year? It can be confusing since people often make contributions for the prior year in the current year. Make sure to note the contribution year on your check. Remember, the deadline for 2011 contribution is April 15, 2012, although that date may be earlier or later depending on when you file your tax returns.
6) There are a wide selection of investment options for an IRA, Have you selected investment choices that will meet your income needs while taking into account your tolerance for investment risk?
7) A skilled financial advisor could help you incorporate your IRA’s as part of your estate plan. Especially if you do not expect to need the income from your IRA, consider consulting a financial advisor on how your IRA will fit your overall investment objectives.