Common IRA Mistakes To Avoid – Part 2

financial advisor

By Joe Globensky, RFC®


IRA mistakes part 2

Earlier this month we discussed six common IRA mistakes people make and what you can do to avoid them.  Believe it or not, there are six more mistakes IRA owners commonly make that we need to talk about and how they can be avoided.

Mistake #7 – RMD Mistakes

There are several mistakes commonly made with Required Minimum Distributions from IRAs.  The first is thinking you have to withdraw your RMD from every IRA account you own.  While you do have to calculate your RMD based on the year-end value of all your IRA accounts, you have the option of which account(s) to withdraw the total RMD amount.

Another mistake is forgetting to take your RMD each year.  In your first year of Required Minimum Distributions, you have the option to delay your distribution until April 1st of the following year.  However, if you do this, you will be required to take two distributions in that calendar year.  Every year thereafter, you must remove your RMD no later than December 31st.  If you forget to take it, or simply forget to include all of your IRA balances in the calculation, your potential penalty is 50% of the required amount that was not taken.  And you also need to withdraw those missed funds as soon as you discover the mistake.

Make sure you read our blog post on the new SECURE Act, as the age for taking Required Minimum Distributions has changed for those that hadn’t turned 70 ½ before December 31, 2019.

Mistake #8 – NUA Mistakes

You may have heard of a tax break for Net Unrealized Appreciation (NUA).  This allows you to qualify for capital gains treatment on distributions of appreciated employer stock that you own inside your qualified retirement plan.  The NUA is treated as a long-term capital gain with no mandatory holding period.  Your beneficiaries can use it too.  And, if you are more comfortable with a smaller tax bill, you can choose to distribute part of the stock and rollover the rest into an IRA.

The stock cannot be rolled to an IRA first.  While you can split your distribution choice between in-kind and rollover, it must be a lump-sum distribution.  Once a mistake is made, it is irreversible.  And even a small violation of the rules can result in the loss of the NUA tax break.  If you are thinking about using this strategy, consult with a knowledgeable financial advisor.

Mistake #9 – Failing to Review Beneficiaries Annually

When establishing an IRA, you are asked for the names of the beneficiaries who will receive the proceeds from your account should something happen to you.  And, the beneficiaries you designate supersede any instructions you may have in your will.  So it’s important that they are kept current.

Change is inevitable.  Life happens.  And when it does, it may warrant changing the beneficiaries on your IRA account(s).  Failing to review this on a regular basis is one of those IRA mistakes that could leave people you care about without the funds they need to live.  If you don’t have a financial advisor reviewing them with you, set an annual calendar item for yourself to review and update if necessary.

Mistake #10 – Dangers With Naming a Trust as Beneficiary

IRA account owners have been known to establish a trust to be the named beneficiary on their IRA account(s).  This was most likely done in order to control the disbursement of funds to a younger generation that may be at risk of making bad money decisions.  In this scenario, the designated trustee would make distributions based on a written trust document.  If the trust was incorrectly established as an accumulation trust instead of a pass-through trust, the monies could be subject to trust tax rates that are significantly higher than those for individuals.

And now, with the passage of the SECURE Act, even those pass-through trusts are less advantageous.  Instead of a trust being able to prolong distributions over the trust beneficiaries lifetime, the IRA must be liquidated within ten years of the IRA owner’s passing.  The trust would then have to decide to either payout those distributions in a shortened time period or retain the money in the trust but subject it to the higher trust tax rates.

Mistake #11 – Mistakes Made by Beneficiaries

Where do we begin?  We’ve seen them all.  The number of IRA mistakes that happen when beneficiaries inherit these accounts is alarming.  Sometimes beneficiaries will want to get access to all the funds at once, thereby incurring a potentially larger tax bill than necessary.  Or they don’t consider distributing the funds over time in an effort to lower, and spread out, the potential tax bill.  Also, they may not think about retaining a majority of these assets, thereby supplementing any retirement savings they have already accumulated. 

Beneficiaries should seek competent advice when inheriting IRAs.  A good financial advisor, along with assistance from a tax professional, can provide options to beneficiaries that they may not have thought of.  There should be time to devise a plan that works within the beneficiaries’ needs and wants, but also minimizes how much is paid out in taxes.

Mistake #12 – Roth Conversions

Sometimes converting traditional IRA dollars into Roth IRAs makes very good sense.  Other times, it definitely does not.  You might want to forego a Roth conversion if your current tax bracket is higher than you think it will be in retirement.  If you don’t have a source of funds outside the IRA to pay the tax bill on the conversion, the conversion may be less advantageous.  And, if the conversion happens later in life, make sure you consider whether you or your beneficiaries gain more from the conversion than what was paid in taxes on the conversion.

There are no do-overs anymore when it comes to converting traditional IRA dollars into Roth IRAs.  Here is another good opportunity to seek competent assistance prior to making the conversion.  Even if it is just to confirm the strategy you developed.

Hopefully I have you thinking about the myriad of IRA mistakes that have been made in the past, and which can possibly be reduced by just making you aware that we’re here to help.  At Connections Financial Advisors, we pride ourselves on educating our clients so they can make informed financial decisions for themselves and their families. 

If you would like to discuss your individual situation, we welcome the opportunity.  And remember, your first consultation is free.  You are under no obligation to work with us afterwards.  But we sincerely hope that you do.  Call our office at (217) 605-8130 to schedule your appointment today.

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual, nor intended to be a substitute for specific individualized tax or legal advice.  We suggest that you discuss your specific tax issues with a qualified tax advisor.

The investment strategies mentioned here may not be suitable for everyone.  Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

Traditional IRA account owners should consider the tax ramifications, age and income restrictions in regards to executing a conversion from a Traditional IRA to a Roth IRA.  The converted amount is generally subject to income taxation.

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