Here’s How To Mess Up With An IRA

Is an IRA really OK when it comes to saving for your retirement? That’s a question you might be asking yourself, whether in good economic times or bad, as you start to think about the time when you’ll leave the work world behind.

Individual retirement accounts are tax-advantaged investing tools for individuals to earmark their retirement savings. Traditional IRAs are tax-deductible; for example, if you put $6,000 into an IRA, your taxable income decreases by that amount. But it’s not a tax-free ride forever. When you withdraw money from that account during retirement, those withdrawals will be taxed at their ordinary income tax rate, which will likely be a lower tax bracket.

IRA’s are a safe bet when it comes to feathering your retirement nest. But keep in mind that they’re not entirely without pitfalls, some of which can be quite costly in terms of lost earnings or significant penalties.

Contributing Too Little…

It’s a simple equation:  Put the maximum amount into your IRA account each year and you’ll reap the biggest reward in terms of retirement savings. Skimp on your annual IRA contributions and you might find yourself looking at retirement savings that are below your expectations.

…Contributing Too Much

Keep an eye on the yearly limit for IRA contributions:  If you exceed the annual cap, the Internal Revenue Service (IRS) will charge a 6% penalty tax on the excess amount for every year it remains in your IRA. You’ll have the option of either removing the additional funds from your account or reducing future contributions to compensate for the overage.

Withdrawing Funds Too Early

If you’re looking to get your hands on some of your IRA funds before the age of 59 1/2, you could get pinched with a significant early withdrawal penalty — 10%, in fact. Some exceptions to early withdrawal penalties apply, including if you’re disabled, purchasing a first home, paying for higher education, or dealing with high out-of-pocked medical bills.

Overlooking A Spousal IRA

If your spouse is out of the workforce — either temporarily, for an extended period of time, or permanently — it doesn’t mean saving for retirement is out of reach. You can contribute to an IRA on your spouse’s behalf, in addition to putting funds into your own account.

Forgetting To Name Beneficiaries

It might be near the bottom of your ‘To Do’ list, but naming a beneficiary, or more than one, for your IRA is highly important. If you don’t designate an account beneficiary, it’s likely that your heirs will not only face legal delays, but also a significant tax penalty while in the process of sorting out the financial details.

Worth noting: a divorce doesn’t necessarily prevent an ex-spouse from receiving IRA money; they can inherit the funds unless you’ve legally removed their name from the account.

Not Contributing If It’s Considered Not Deductible

If your income is too high, or if you also have a 401(k) or other retirement plan through your work, you may not be able to claim a tax deduction for your IRA contribution. But just because you can’t claim a tax write-off, don’t write off a solid opportunity to grow your money, and defer paying taxes on it until retirement.

Overlooking Required Withdrawals

Slow and steady wins the race, as they say, but being slow to make required minimum distributions (RMDs) from an IRA can cost you. When you reach age 70 1/2, the IRS requires you to make staggered annual withdrawals from your IRA. If you don’t withdraw enough, you could be hit with a whopping 50% excise tax on the amount you didn’t deduct from your account.

Ignoring Your IRA

An IRA is an investment account, as opposed to a savings account, which means you want to stay on top of what’s in the account and how your investment is performing. Your IRA could include CDs, stocks, bonds, mutual funds, even some real estate investments.

To maximize your investment return, check to see if your IRA has the right investment mix for your age; the closer you are to retirement, for example, you might want to avoid riskier investments such as stocks.

Putting Off Contributions

The April tax deadline is looming, and you’ve decided last minute to make an IRA contribution before the cut-off date. Yes, you’ll benefit from the tax deduction, but you’ve missed an opportunity for your IRA investment to compound, which can add up to a sizable amount of earnings over the life of your IRA account. Hesitation results in waste, in this case.

Stopping Contributions In Later Years

The clock has been ticking, and now you’re turning 70 1/2:  Time to start making mandatory withdrawals from your traditional IRA, and cease putting money into your account.

With a Roth IRA, however, you can continue contributing regardless of your age. Even if you aren’t counting on the funds for your retirement, an IRA account can be a significant source of income for your heirs, who will be able to make tax-free withdrawals.

As you can see, there’s plenty to unpack here. But the bottom line is this- get to know what the IRA game is all about, as your older self might just thank your younger self many times over.