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10 IRA Planning Mistakes & How to Address Them

An Individual Retirement Account (IRA) is an account designed for building retirement savings. Unlike an ordinary savings account, it allows you to purchase investments, such as mutual funds and stocks, and offers tax breaks that can save you thousands of dollars over the life of the account.

First things first: Not everyone is eligible for all the perks of traditional and Roth IRAs. Your income level will determine whether you’re allowed to contribute to a Roth IRA. Anyone — regardless of income — can contribute to a traditional IRA. But the amount of your traditional IRA contribution that you’re allowed to deduct from your taxes may be limited by your income and whether you or your spouse has access to a retirement plan at work.

If you find you’re eligible for either account, here are 10 common mistakes to consider so you can  earn the most for your money:

1. Not naming or updating IRA beneficiaries.

Not listing a primary and contingent beneficiaries may result in the distribution of the IRA assets to the IRA owner’s estate, resulting in accelerated distribution and taxation. Not keeping beneficiary designations current and coordinating them with other estate planning documents can lead to conflicts and unintended results.

2. Making inappropriate spousal rollovers.

Most IRAs list the owner’s spouse as the primary beneficiary. One of the most popular strategies for a spousal beneficiary is simply to roll the inherited IRA into their own IRA. But in some cases it can be more tax efficient for a surviving souse to keep the IRA as an inherited beneficiary IRA or disclaim the assets, thereby allowing them to pass the contingent beneficiary.

3. Rolling low-cost-basis company stock into an IRA.

Distributions from a qualified plan such as a 401(k) are generally taxes as ordinary income, If company stock is rolled into an IRA, future distributions are taxed as ordinary income, If, instead, the company stock is taken as a lump-sum distribution from the qualified plan, only the cost basis of the stock is taxed as ordinary income, Unrealized capital appreciation is not taxed until the stock is sold, at which time it is taxed as long-term capital gains, which for many is a lower rate than ordinary income, Be sure to talk with your tax advisor.

4. Not taking advantage of a Roth IRA.

A Roth IRA is a potentially valuable retirement resource. Not only are qualified withdrawals tax free, but Roth IRA distributions do not impact the taxability of Social Security, and Roth accounts pass to beneficiaries tax free as long as the account is at least five years old. There are income limits that affect eligibility for a Roth IRA, so be sure to discuss this option with your financial advisor.

5. Not taking advantage of maximum contribution limits.

For tax year 2019, the most an individual is allowed to contribute annually to a Roth or traditional IRA is $6,000, or $7,000 a year if you’re age 50 or older. (Those limits are up from $5,500 and $6,500 in 2018.)  However, your income will largely determine:

  1. If you’re eligible to contribute to a Roth (partially, fully or even at all).

  2. How much of your contribution to a traditional IRA you’re allowed to deduct from this year’s taxes.

6. Assuming that a nonworking spouse cannot contribute.

The truth is that separate “spousal” IRAs may be established for spouses with little or no income to the same limits as the working spouse.

7. Missing important dates.

Estate taxes, if applicable, are due nine months after the IRA owner’s death. The same deadline applies to beneficiaries who wish to disclaim IRA assets. By September 30 of the year following the year of the owner’s death, the beneficiary whose life expectancy will control the payout period must be identified. Generally, IRA beneficiaries who want to receive distributions over a life expectancy must begin taking required distributions by December 31 of that same year.

8. Taking the wrong required minimum distribution (RMD).

Once IRA owners reach their seventies they are required to take the RMD out of their accounts each year, based on the value of their non-Roth IRAs. Those who do not take enough out each year may be subject to a federal income tax penalty of 50% of the amount that should have been taken as a RMD but was not. Consolidating retirement assets may make it easier to manage these distributions.

9. Placing the title of an IRA in trust.

Making a trust the actual owner of an IRA causes immediate taxation—including the 10% penalty tax if the IRA holder is under age 59 ½.

10. Paying unnecessary penalties on early (before age 59 ½) IRA distributions.

As long as withdrawals are made in accordance with the requirements of IRA Code Section 71(t), there is no need to pay penalties on distributions from IRAs taken before the owner is age 59 ½. Section 72(t) allows for three calculation methods to determine substantially equal periodic payments based on the owner’s life expectancy. Payments must continue for five years or until age 59 ½, whichever is the longer period of time.

There are four fundamental steps to starting an IRA:

  1. Decide how much help you want: What type of investor you are — hands-on or hands-off?

  2. Choose where to open your IRA: Your choice should align with your investor type above.

  3. Open an account: It takes just a few minutes.

  4. Fund the account and get started – setting up automatic monthly contributions is recommended.

For additional information on retirement planning or to discuss setting up an IRA account, contact the Financial Advisors with the credit union. Whether your financial objective is to preserve your wealth or build your nest egg, they’ll work with you to pursue your goals.

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