Top 10 IRA/401k Mistakes to Avoid
If you own a IRA/401k, you’ll want to avoid these common mistakes if you want your IRA/401k to avoid going to court, dodge a tax meltdown, subject to high fees and be passed onto your heirs.
1. Not Naming a Beneficiary Not naming a beneficiary is a guarantee that your IRA/401k will go to court and your estate will inherit your IRA/401k. Believe it or not, something as simple as naming a beneficiary on a beneficiary form could save hundreds, thousands, or perhaps millions. With no living beneficiary, your IRA/401k account will through the costly and time-consuming process of probate and must be emptied within five years.
How bad can this be?
A lot!
For example, if you have $100,000 and leave it to your estate, your IRA may be hit with a tax up to 75%. Could you imagine leaving only $25,000 to your heirs?
Ouch!
Now, if you named a beneficiary, after your death, he/she may be able to stretch the distributions from that inherited IRA for many many years, while at the same time, grow that IRA. A small $100,000 inherited IRA could grow to several million dollars if your beneficiaries have the option to take minimum distributions.
2. Not Reviewing Your Beneficiary Designations Regularly Did you hear the story about a school teacher who had accumulated several million dollars in her retirement account, but when she died, her husband found out he wasn’t entitled to any of it?
Turns out she started teaching before she met him, and she named as beneficiaries her mother, uncle, and sister. Both her mother and uncle had died, so the sister got everything — and wouldn’t share any of it with the husband.
She went to her death thinking that maybe her husband was taken care of, but it wasn’t that way and he didn’t get one cent.
Every year, we hear countless stories like this. Do you want your loved ones to have to go through such heartache?
Do a annual review of your 401k and IRA, especially if there’s a recent death, divorce, disability or marriage.
3. Not Knowing Your Age Limits Most people are aware that they can begin taking money out of their IRA/401k at age 59 ½. However, most people don’t know that they are required to start taking minimum distributions at age 70 ½ as mandated by the IRS.
The penalty for not taking the distribution: 50% of the amount that should’ve been taken.
That’s huge!
If you have multiple IRA/401ks, it’d be best to consolidate them into one or two IRA accounts so it’s easier to calculate and take the required distributions. Having more than one account requires you to take distributions from each, or you must calculate the required distribution from all accounts and take them from one account.
Consider consolidating your IRA/401ks into one single IRA account. It’ll make your IRA and your life easier to manage.
4. Rolling Over Your 401k the Wrong Way When you change jobs, you may wish to do what’s called a 401k rollover, either to a new 401k or IRA. This process, when done properly, should be a non-taxable transaction.
However, if done improperly, you not only lose the tax-deferred status of the 401k, but face huge consequences of the IRS.
For example, when you’re performing a 401k rollover, the IRS provides you with a 60-day window to rollover the funds to another 401k or to an IRA. If you fail to complete the rollover within this window, your entire 401k becomes taxable as it would be considered a complete withdrawal. And, if you’re under the age of 59 ½, you’ll also have to pay a 10% penalty.
You can avoid all of these problems through a simple direct transfer, where your 401k funds are transferred from one custodian to another. You never have to touch the 401k funds, thus you do not have to worry about receiving a lump-sum distribution check and making sure you deposit the funds in a new IRA within the 60-day window.
If you have multiple IRA’s or other qualified retirement accounts and would like to consolidate these assets into one account, we can help you manage the process and make sure it is done as efficiently as possible.
5. Taking More Than One Distributions in a Single Year If you take two or more distributions in a given year, you put yourself in a higher tax bracket, and you could pay more taxes unnecessarily.
For example, you take one distribution in January 1st and then another in December 31st of the same year. While you may think you’re taking one for last year, and then one for next year, they’re actually for the same year.
6. Failure to Seize a Bear Market Opportunity Most people have heard of the Roth IRA and know that they can convert from a traditional IRA to a Roth IRA. But few ever done.
Why?
Because the tax on the conversion becomes immediately due. For some people with a large IRA account, that’s a hard thing to swallow.
However, the current bear market may present the perfect time to do a Roth IRA conversion.
The one good thing about doing a Roth IRA conversion during a bear stock market is that when the IRA balance is down, you actually pay less in taxes on a reduced value, and future distributions are tax free in a Roth IRA.
If you’re total adjusted gross income is less than $100,000 you may want to consider converting all or part of your IRA during a bear market as it presents you with a tremendous opportunity for future growth and tax-free income.
Some advantages of a Roth Conversion include:
- Future tax-free income
- No required minimum distributions like a traditional IRA
- Saving taxes on Social Security income, since income from a Roth IRA is not counted
- Reducing taxes after one spouse dies, since income from a Roth IRA is tax-free, it does not bump the newly single spouse into a higher tax bracket—unlike that of a traditional IRA
7. Dying With a Loaded IRA/401k Congress has made IRA/401ks appealing retirement savings vehicles for many Americans. However, Congress has also made it possible for Uncle Sam to be a partner in both.
You see, IRA/401ks are tax-deferred accounts and as such, they enjoy the benefits of compounding growth without immediate taxes on the earnings.
However, when you reach the age of 70 ½ , the IRS mandates that you must begin taking minimum distributions. It is then that you must pay ordinary income taxes on those distributions.
And, when you die, it gets even worst. You may even lose up to 75% of the value of your IRA/401k to estate and income taxes!
If you have no intention of spending your IRA/401k, it may be to your advantage to utilize IRA Transfer Strategies to reduce both your estate and income taxes. Doing so could result in far superior outcomes for you, your heirs and/or your favorite charities.
8. Having Too Many IRA/401k Accounts People with many IRA/401k accounts often cite the reason why they have so many is to diversify and reduce fees. However, what they may be doing is actually the opposite.
Not only is it difficult to manage multiple accounts, you may also forget to or take the wrong amount of required distributions. The IRS is not very forgiving when it comes to required distributions. A penalty up to 50% of the amount you should have distributed can be imposed if you do not take a distribution or if you do not take enough.
A simple solution would to consolidate all your 401ks and IRAs into one or two accounts. This way it would be much easier to manage, allow you to see what you’re working with, reduce fees, simplify your distributions, name your beneficiaries, etc.
9. Stashing Your IRA/401k in a Bank CD Most people put their money into an IRA/401k with the potential for higher growth. However, many have experienced the turbulence in the stock market and have since flocked into CDs for their safety. However, this may not be the best option to grow your IRA/401k.
While CDs are FDIC-insured and convenient, CDs do have certain limitations that make it unlikely candidates for an IRA/401k.
Yields on CDs have been lower than the rate of inflation in one out of every five years. After subtracting taxes and the rate of inflation, the return on any given CD has been negative about 50% of the time.
CDs offer no guarantee of income for life. The purpose of an IRA/401k is to create income for retirement; placing a CD inside an IRA/401k does not serve this purpose well.
Banks are not required to give you access to your CD principal during the term of the CD and may even prevent you from making early withdrawals. Any early withdrawals will incur interest penalties.
Even though CDs are FDIC-insured, CDs are only as safe as the bank that holds them.
The real returns on most CDs, after taxes and inflation, may fall into negative numbers. Unfortunately, a reliance on CDs to fund your retirement plan could result in a 40% shortfall at retirement age and may require you to work during your retirement.
10. Putting Your IRA into a Variable Annuity Some people believe that the only way to defer taxes is to put their IRA into an annuity, especially a variable annuity.
That’s not true!
The fact is, an IRA is already a tax-sheltered vehicle. Putting an IRA/401k into a variable annuity is like putting an IRA inside another IRA; you gain no tax advantage from doing this.
Why shouldn’t you put an IRA inside a variable annuity? High fees. Fees are a necessary component in just about every variable annuity, but in many cases they are too excessive.
In general, total annual fees can range from anywhere 2% to 5%. These fees are taken out every year; it doesn’t matter whether your account gains or loses money.
For example, if you gained 12% in one year and have 3% in fees, then your net gain is 9%. However, if you lost 10% in one year and have 3% in fees, then you net loss is 13%. Most people believe the fees are only assessed when your account increases in value, but that is certainly not the case.
Today’s variable annuities carry many types of fees, among them administrative fees, mortality and expense fees, management fees, and rider fees. These fees obviously vary from one annuity to another.
If have an IRA inside a variable annuity, do yourself a favor, get a competent financial advisor to review your IRA for any excessive and unnecessary fees. There’s absolutely no reason for you to assume all the risk, and pay some ridiculous fees which do not serve you well.
You may also read our article on Variable Annuity Rescue Plan.
To avoid these common IRA mistakes and more, click here and an Advisor will contact you promptly for a complimentary review of your IRA for no cost or obligation.
