5 Dumb IRA Mistakes Even Smart People Make
You know how important it is to save for your retirement. So to help you reach your financial goals, you've set up an IRA.
Setting up and contributing to an IRA is a good first step. But even financially savvy people make key mistakes when contributing to IRAs — mistakes that can cost them plenty of retirement dollars.
The good news? It's actually fairly easy to avoid these errors. Craig Howell, vice president of business development at San Francisco's Ubiquity Retirement + Savings, said that consumers can do so with just a bit of education.
"It doesn't take much to educate yourself on how IRAs work," Howell said. "You do have to pay attention to your IRAs. A lot of people set them up and then ignore them. But if you do just a bit of research, you can avoid making mistakes with that money."
Here are the most common mistakes even smart people make when it comes to building the savings in their IRAs. (See also: 5 Important Things to Know About Your 401K and IRA in 2016)
1. Not Contributing Enough
The more money you deposit in your IRA, the more money you'll have to help fund a happy retirement. That seems obvious. But many people, even financially savvy ones, simply use their IRAs as a place to stash money, not as a place to grow it.
This is because many people first fund their IRAs from dollars they roll over from an employer-sponsored 401K when they change jobs. They take that money, deposit it in an IRA, and ignore it. Sure, depending on the economy, these dollars will slowly grow. But they won't grow nearly as fast as they would have if their owners were making regular contributions.
And this is far from an uncommon mistake.
"I believe that the number one mistake that people make is not contributing to their IRAs at all," said Joe Roseman, managing partner at retirement firm O'Dell, Winkfield, Roseman & Shipp in Charlotte, North Carolina. "That is easily the number one mistake."
A 2015 study by the Employee Benefit Research Institute found that only 7% of investors contributed to their traditional IRA accounts in 2013. Investors who owned Roth IRAs did a bit better, with 26% contributing in 2013.
2. Taking the Silo Approach
Jim Poolman, executive director of the Indexed Annuity Leadership Council and former insurance commissioner of North Dakota, said that too many investors never consider how their IRAs fit into their overall retirement plans.
Of course, too many people never calculate how much they'll need to save for their retirements in the first place. So when they invest dollars in an IRA, they do it in a haphazard way, contributing when they are fortunate enough to have some extra money. A better approach is to contribute on a regular schedule that is based on all the savings vehicles you are using to fund your retirement, Poolman said. For example, if you contribute to an employer-sponsored 401K every pay period, consider doing the same for your IRA. Automatic account transfers from savings or checking balances can help you achieve this.
"It is important to look at your full retirement plan and how your investment vehicles fit in," Poolman said. "Evaluate all of your investments together so you have a proper balance to meet your time and investment objectives. Some people look at the different vehicles like an IRA in a silo, and don't consider it in the entire financial or retirement plan."
3. Forgetting Their Required Minimum Distributions
IRAs come with generous tax breaks — but don't think you're getting these for free. The federal government requires that when you turn 70-and-a-half you begin taking regular withdrawals from your traditional IRAs, withdrawals on which you will have to pay taxes. (If you have a Roth IRA, you won't have to do this.)
How much you'll have to withdraw each year depends on how much money you've saved in your IRA. If you forget to make these withdrawals, or if you don't take ones that are large enough, the government will levy a 50% penalty against you. If you were supposed to withdraw $5,000, not only will you have to catch up with that withdrawal — paying taxes on it — you'll also have to pay a penalty of $2,500.
"Uncle Sam, being the nice gentleman that he is, at some point if he gives you something, he also takes it away from you," Roseman said. "If you don't take your required minimum distribution, he is going to hit you with a very nasty penalty."
4. The Rollover Mistake
Say you want to move the dollars in your current IRA to a new one. Or maybe you've changed jobs and you want to take the money from your old 401K account and deposit it in an IRA. You can roll those funds over.
In a rollover, you'll receive a check for the amount of money in the retirement account you are closing. You then use that money to start a new IRA. But there is a catch: If you don't deposit your dollars into a new account within 60 days, the IRS will consider that money as income, which means you'll have to pay taxes on it.
And if you are under the age of 59-and-a-half when you do this, you'll also be hit with a 10% penalty. If you withdrew $10,000 and failed to move it into a new IRA within 60 days, you'd have to pay a penalty of $1,000.
Also, you can only do one rollover a year. A better choice? Sign up for a direct transfer of your dollars from one retirement savings vehicle to your new one. Doing so will send your money directly to your new IRA without you ever receiving a check first. It's a way to eliminate this extra step and make sure that you don't accidentally trigger the 60-day penalty. You can also make unlimited direct transfers in a year.
5. The Wrong Beneficiary
When you die, you want the money left in your IRA to go to the right beneficiary. But Roseman said that too many investors forget to update their IRA's beneficiaries when their lives change.
This most often happens in cases of divorce, he said. Divorced or remarried investors often forget to change their beneficiary forms. Their IRA dollars are still scheduled to go to their ex-spouses, not their current ones, after they die.
"You are dead and your current spouse is counting on the $300,000 in your IRA," Roseman said. "But the beneficiary designation still says that this money goes to the ex. There have been many court cases saying that the beneficiary designation rules. It overrules a trust agreement and it overrules a will. That is a huge mistake that investors make. Any time there is a change in their lives, people need to re-do those beneficiary forms."
Are you making any of these common IRA errors?
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