About 40 percent of U.S. households—nearly 50 million—own individual retirement accounts (IRAs) that provide tax-advantaged options for saving. The Pennsylvania Institute of Certified Public Accountants offers the following tips on how to avoid some common mistakes people make when managing IRAs.
Mistake #1: Fail to Focus on Beneficiaries
Naming a beneficiary makes it easier for your loved ones to access your accounts when you die. It can also help preserve tax benefits for your heirs and guarantee that your money goes to the right people. Be sure to review and update your beneficiaries as necessary, especially after a marriage, birth of a child, divorce, or the death of a named beneficiary. It’s also a good idea to talk to your CPA about the tax implications for those who might inherit your IRA.
Mistake #2: Wreck Your Rollover
If you want to move your IRA investment from one account to another, process a direct rollover or direct transfer. Your IRA money will flow directly from one financial institution to the new financial institution and have no tax effect. Even if you have physical possession of the check, it isn’t made payable to you. The check is made payable to “Trusted Financial Institution for benefit of [Your Name].” Avoid processing an indirect rollover. This is when you withdraw the money directly (the check is made payable to you). An indirect rollover creates a taxable event. If you make this mistake, you have only 60 days to correct your error by making a corresponding IRA investment. If you don’t make the IRA investment in time, 100 percent of the withdrawal is included in your taxable income for the year and a penalty of 10 percent will be assessed if you are younger than 59½.
Mistake #3: Overlook the Roth IRA
A Roth IRA may or may not suit your needs, but it’s worth finding out what it has to offer. The income you receive from a Roth IRA is not taxable to you in retirement, is not taxable to your beneficiaries, and there is no requirement to take a minimum distribution after age 70½. Note that, unlike a traditional IRA, your contributions to a Roth IRA are not tax deductible. You can contribute as much as $5,500 to a Roth IRA ($6,500 if you’re 50 or over by the end of the year) as long as your income falls below certain levels. However, you can convert a traditional IRA to a Roth IRA no matter what your income. There are tax consequences from that conversion, though, so be sure to consult your CPA about the right steps for you.
Mistake #4: Don’t Take the Right Distribution
While it’s a generally bad idea to tap your IRA too early, you can’t leave the money in a traditional IRA forever. By April 1 of the year after the year you turn 70½, you must begin to take required minimum distributions each year. If you don’t, you could face a 50 percent tax on the amount not taken as required. The required minimum distribution varies based on your year-end account balance, age, and other factors. Please consult your CPA for guidance. Of course, you can also withdraw more than the minimum required distribution, but be sure to portion out your withdrawals appropriately if you need them to last a lifetime. Distributions from a traditional IRA are included in your taxable income, and your CPA can help you determine how that income will affect your annual tax bill.
Mistake #5: Do Nothing
When you fail to set up or contribute to a retirement account—whether it’s a plan offered by your employer or an IRA—you lose out in two ways. First, the amount you could have saved won’t be there when you’re ready for retirement. Second, you also miss out on all the interest or dividends that might have grown tax free in your account over the years.
Your Local CPA Can Help
Retirement planning is important, but you don’t have to do it alone. Your local CPA can offer advice that can help you build and maintain the nest egg you’ll need when you’re ready to retire. Be sure to turn to him or her with all your financial questions. For more resources, including a retirement planning brochure or CPA locator, visit PICPA's Consumer page