IRAs are a valuable way to save for retirement. You can transfer money to and from employer retirement plans on a tax free basis. You are listed and protected as the owner instead of your employer. You can choose from a wide variety of products, custodians and individual investments. And you get to defer taxes on your growth. But IRAs are not without danger. Here are eight mistakes that you can make that can cost you or your beneficiaries a fortune.
One of the first mistakes that I see is not understanding when and how you must take your Required Minimum distributions (RMD). If not done properly there is an excise tax of 50% of the amount you were supposed to take for the year. So if you were supposed to take a $15,000 distribution then you will be penalized $7500 if you do not take your RMD properly.
The first RMD is required in the year that you turn age 72. You can take it as late as April 1st of the next year but I generally recommend that you take it in your 72nd year. That’s because if you wait until your 73rd year then you will need to take two distributions that year to avoid the excise tax and that could put you into a higher tax bracket for the year.
The second mistake is not knowing how to figure out your Required Minimum Distributions. If your spouse is not more than 10 years younger or you are single, then you must use the Uniform Lifetime Table. If your spouse is more than 10 years younger as of January 1st then you must use IRS Publication 590 Joint and Last Survivor Table.
Once you figure out which table to use then you can determine your account balance as of December 31st of the previous year. Once you have that figure then you can follow this equation: Balance as of December 31st / Divisor from the Table = RMD. Here is an example: $100,000 / 25.6 = $3906.
Two words of warning. You need to make sure that you are using the current year’s table. The table factors change every year so this is important. The other word of warning is that if your IRA is in a variable annuity then there are specific rules that you need to follow. In this case I recommend that you contact your variable annuity company to determine the rules.
Another mistake I see over and over is taking the RMD from the wrong account(s). Many people don’t understand the types of accounts they should be taking the RMD from. Traditional IRAs, profit sharing plans, 401(k) accounts, 403(b) accounts and TSA accounts all represent accounts you need to take RMDs. When deciding the appropriate accounts to take RMDs it is very important that you select the right accounts. Here I recommend talking to a qualified financial advisor to ensure that you are taking your RMDs from the appropriate account(s). Remember that there is a 50% excise tax if you do not withdraw from the proper accounts.
Now on to a mistake that doesn’t have anything to do with RMDs! Moving from one retirement account to another can be tricky and can result in a taxable event. If you are moving from a traditional IRA into another traditional IRA then you need to complete the transaction within 60 days or the transaction will become taxable. What about rolling over from an employer retirement plan into an IRA? Well, a rollover from an employer retirement plan into an IRA is subject to a mandatory 20% withholding for taxes. If you are moving from a Roth IRA to another Roth IRA then you have 60 days to move the money or you may face a 10% penalty.
So how can you avoid taxes, withholding and possible penalties? Well a trustee-to-trustee transfer is the way to do that. That is to say that the rollover or the transfer goes directly to the new trustee. Since the money does not pass through the owner’s hands it is not subject to taxes, withholding or penalties. They money still belongs to the owner but it transfers directly to the trustee.
Here is another potential mistake but this one is the responsibility of the beneficiary of an IRA. Since the SECURE Act of 2019, most non-spousal beneficiaries are required to take the proceeds from their IRA over a 10 year period. In many cases beneficiaries make the mistake of taking a lump sum distribution of the entire IRA. Unfortunately that can put the beneficiary into a higher tax bracket for that year and they can pay more in taxes by taking a lump sum. In most cases it makes more sense to take the inheritance over time (maximum 10 years) to limit the amount of taxes that the beneficiary will pay.
This next mistake involves taking a cash distribution instead of an “in-kind” distribution. An in-kind distribution is a little know alternative strategy for taking withdrawals and should only be done in special circumstances. An in-kind withdrawal is a distribution made in the form of unsold securities (investments) or other property, rather than in cash. More simply put, it’s any distribution NOT made in cash.
A distribution in-kind can be made in several different situations, including a stock dividend, inheritance, or taking securities out of a tax-advantaged account. There are some cases when taking an in-kind distribution will result in more favorable tax treatment than taking the distribution in cash. Since this is a more complicated strategy, I don’t have the space to explain it here, but feel free to contact me or another qualified professional advisor for a complete explanation.
Another potential mistake is for the spouse to take a lump sum death claim payout of an IRA instead of retitling their decedent spouse’s IRA into their own IRA. By retitling into their own IRA they can continue to defer taxes and let the money grow into the future. The same is true for a decedent’s employer retirement plan. The spouse can roll the money into their own employer retirement plan or into an IRA or Roth IRA in their own name thus avoiding the taxes of taking a lump sum payout.
Roth IRAs are very often misunderstood as well. This can lead to mistakes when planning for retirement. Roth IRAs can create the possibility of tax-free income in retirement. As long as the Roth account is held for 5 years the contribution and the growth will not be taxed when it comes out of the account in the future. There will be no RMDs during the life of the participant or during the life of the spouse. One thing of note about Roth IRAs is that the contributions into Roth IRAs are non-deductible.
IRAs are a valuable tool for investing in your retirement future. However, they are subject to complicated rules. Knowing those rules help you to be able to select the best options and avoid costly mistakes along the way.
Jeff Brindley is a financial advisor at RWS Financial Group. He contributes his financial column Brindley’s Briefs to Gazeta Dielli every month. You can reach him at 833.797.4636 X137 or via email at Jeff.B@RWSGroup.org.
Securities offered through Registered Representatives of Cambridge Investment Research, Inc. a broker-dealer, Member FINRA/SIPC. Jeffrey Brindley, Investment Advisor Representative, Cambridge Investment Research Advisors, Inc. a Registered Investment Advisor. RWS Financial Group is not affiliated with Cambridge Investment Research.