An Individual Retirement Account (IRA) can be a powerful tool for securing your financial future, but navigating its rules and regulations can be tricky. Making mistakes with your IRA can lead to significant financial consequences, so it’s essential to be well-informed. To help you avoid potential pitfalls, here are three common and costly IRA mistakes that can easily be prevented:
#1 Beneficiary Mistakes
An IRA passes on to beneficiaries, not through a will. Therefore, it’s crucial to designate the right beneficiary while you are still alive. Not doing this can result in major problems.
To avoid such problems:
- Review your beneficiary designations annually.
- Consider setting reminders on significant dates like your birthday or the start of the year.
- Remember to check beneficiaries for other accounts, such as 401(k)s, as they count as well.
- Name contingent beneficiaries who will inherit the IRA if the primary beneficiary passes away.
In some cases, using a trust as the beneficiary might be appropriate, offering financial protection in certain circumstances or for beneficiaries who might not be financially stable. If you have a complex family dynamic, it’s advisable to consult with your investment manager, estate attorney, and accountant for a proper beneficiary plan.
#2 Not Accounting for After-Tax IRA Contributions
Differentiating between pre-tax and post-tax (after-tax) contributions to a traditional IRA is crucial. Pre-tax contributions are tax-deductible, reducing your current taxable income, but they become taxable upon withdrawal. On the other hand, after-tax contributions are not tax-deductible initially, but they are tax-free upon withdrawal, with only the earnings being taxable.
To prevent complications, accurately track your contributions and specify whether they are pre-tax or after-tax. The responsibility lies with you, not the investment custodian, to differentiate between the two. Failing to do so could result in after-tax contributions being taxed again upon withdrawal, contrary to the rules.
If you’ve made after-tax contributions, you must file Form 8606 to account for them properly. This form is also essential if you plan to perform a Roth IRA conversion, as after-tax contributions affect the process. Don’t overlook this step when managing your IRA; it can save you from unexpected tax liabilities.
#3 Using the Wrong RMD Table
Many people are unaware that there is more than one table for calculating Required Minimum Distributions (RMDs) from an IRA. If you have a spouse who is the sole beneficiary and is more than ten years younger than you, you might be eligible for a more favorable RMD table.
Using the incorrect RMD table can lead to unnecessary tax payments.
To avoid this mistake, familiarize yourself with the different RMD tables and use the one that best applies to your situation. Consulting with a financial advisor can be helpful in understanding and optimizing your RMD calculations.
In conclusion, an IRA is a valuable tool for retirement savings, but it’s essential to be aware of its nuances and potential pitfalls. Take your time, research thoroughly, and seek expert advice to ensure you make the most of your IRA while avoiding costly mistakes. It’s important to routinely check your IRA plan and keep a checklist to ensure that you’re on top of your beneficiary designations, RMDs, and other crucial IRA planning strategies. Having a second set of eyes to help you navigate the complexities can prove invaluable in securing your financial future.