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4 Mistakes IRA Investors Can't Afford

Owen Schrum
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Individual retirement accounts have been the ugly duckling of investments.

No longer. IRAs now account for more than $8.2 trillion of American's retirement assets. More than 42 million households count on IRA's to help fund their retirement.

IRAs started off simple in 1974, but like our tax code have grown more complex. These complex rules often lead to mistakes. And these mistakes can be terribly costly. Here are four mistakes you cannot afford to make with your IRA account.

Rollovers. There are two ways you can move or roll over your IRA: direct rollover and trustee-to-trustee transfer or by indirect rollover.

[See: 10 Investing Themes to Remember for 2018.]

In a direct rollover, either the transfer occurs between trustees or a check is made out to the other financial institution. In an indirect rollover, the check comes to you, and you have 60 days to deposit into another IRA or pay taxes due on the full amount.

Let's make this simple. Always do a direct transfer. And a trustee-to-trustee (financial institution to financial institution) is best. You do not have to worry about taxes and you can do this as often as you like.

There are two big issues with indirect transfers.

When you get the money, the clock starts, and it must be deposited into another IRA in 60 days. Otherwise it is fully taxed, and if you are younger than 59½ there is a 10 percent penalty.

And, you are limited to one indirect rollover every 365 days. Even if you have several IRA accounts, you still are limited to just one. Even if you redeposit it within 60 days, if you have done it more than once, it is a fully taxable distribution and you must pay the 10 percent penalty if you are younger than 59½.

Required minimum distributions. At 70½, the federal government says it wants to start taking its share of the money in your IRA. So, in come the rules and regulations that state how you must start taking money out of your IRA and paying taxes on that money.

Here's where it gets confusing. People often don't consider all their accounts. They may have several accounts; they may have husband and wife IRAs or 401(k) plans. In their mind, if it's in the same tax return, it doesn't matter where they take the money for the RMD as long as they take it.

Wrong. You can't do that. And if you do, it's a 50 percent penalty on the amount you should have taken but didn't. That's right -- half. That's what we meant earlier that IRA mistakes could be costly.

Each spouse must take their own distribution, based upon their age. Each person must aggregate or add up all their IRA's to determine their RMD. The RMD then can come out of one or a combination of accounts, just so you take out the right amount to be taxed.

[See: 11 Steps to Make a Million With Your 401(k).]

IRA required minimum distributions are separate from 401(k) distributions, which cannot be aggregated.

Inherited IRAs. So many times, we've seen the case where someone has inherited an IRA from a parent, and they take the money out with plans to meet with someone to decide how to invest it.

You cannot do that. The entire amount becomes taxable as soon as you do.

An inherited IRA must be transferred to a specifically titled "inherited IRA" or "beneficiary IRA" and you must start taking distributions from that IRA. You do get a tremendous gift here. "Stretch" provisions allow you to take the required minimum distributions over your lifetime, effectively reducing the amount you must pay taxes on at any one time.

Meanwhile, check every retirement plan account. Make sure you have named a beneficiary and it is correct and the information has been updated. People forget, divorces happen, and custodians make mistakes.

Next, name contingent beneficiaries.

Be careful naming trusts as beneficiaries. If you do, get the advice of an attorney who specializes in this area.

Always remember, the beneficiary form trumps the will and other legal documents.

Beware of scams. If you watch or read enough these days, you may hear some pitch or promotion about a special investment for your IRA. Beware of any promotion that says an IRA strategy or investment is approved by the IRS. The IRS does not approve or recommend IRA transactions or investments.

If you make the mistake of engaging in what the IRS deems a "prohibited transaction," the entire IRA is deemed to have been distributed on Jan. 1 and you have to pay taxes on the entire amount.

[See: What Everyone Should Know About IRAs.]

The takeaway is that IRAs are both very important to your retirement and complicated to a degree that any mistake can be very costly.



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