Six Common IRA Mistakes to Avoid
By Joe Globensky, RFC®
Even if you haven’t ever wondered what the most common IRA mistakes are, knowing what to avoid could save you thousands of dollars over your lifetime.
For many of us, retirement accounts make up a significant portion of our financial wealth, or they probably will in the future. Understanding how to take advantage of these accounts is important.
So take a few minutes now, and on our next blog post, to learn about IRA mistakes that are made regularly, and what you can do to avoid them.
Mistake #1 – Not Contributing Enough
Many IRA account owners make the mistake of treating their IRA account as a static investment. Maybe it was funded with money from a retirement plan from a former employer. Or maybe it was started in a year when you had excess funds, but no contributions have been made since. Whatever the reason, this is not a good retirement savings strategy.
The first thing you should do is gauge your current retirement savings. If you’re falling behind, you should look to improve your savings strategy. In 2020, the maximum IRA contribution is $6,000 for those under 50 years old, with an additional $1,000 catch-up provided to those 50 and older. These contributions don’t have to be made all at once, or even in these amounts. In fact, it might be easier for you to start with a small monthly amount with a goal to increase it as the year progresses. But the important point is to start now rather than wait for “a better time.” Retirement is coming. The longer you wait to save for it, the harder it will be to obtain the retirement you want.
Mistake #2 – Excess Contributions
Has this happened to you? You plan well all year only to find that you have contributed too much to your IRA account. Unfortunately, it does happen. Many times, this is a simple error in classifying to which tax year the contribution applies. Or, you have multiple IRA accounts, contribute to each one, and inadvertently exceed the maximum contribution. Remember, the contribution limits noted above are not per IRA account, it’s per person.
If you find that you have contributed too much, you’ll want to fix that as soon as it is discovered. There could be penalties if you don’t. And, don’t just remove the excess contribution. You have to remove any earnings on the excess contribution as well.
Mistake #3 – Rollover Mistakes
If you choose to rollover a qualified retirement plan (e.g. 401k) from a previous employer into an IRA account, there is a direct way to do it, and an indirect way. You want to choose the direct way. This is where the plan sponsor makes the check payable to the financial institution that holds your IRA account. While it may be mailed to you, as long as it is deposited into your IRA account, there are no tax ramifications.
The indirect rollover could end up costing you a significant amount of money. If you take receipt of the funds, you have 60 days to get it deposited into an IRA account. Otherwise, the IRS will assume you cashed it out and you’ll owe income taxes and possible penalties based on your age. While you may have a good reason for taking receipt of the funds, even temporarily, use extreme caution.
Mistake #4 – Taking an Early Distribution
It may be helpful to look at your retirement account as exactly that, something you won’t touch until retirement. If you have an emergency fund set up in addition to your retirement account(s), you shouldn’t need to touch your retirement account early. Because if you do, you will probably be assessed a penalty, in addition to income taxes.
In most instances, taking money out of retirement accounts before you turn 59 ½ years old will incur a 10% early withdrawal penalty. There are some exceptions to the penalty for things like college costs, first home purchase, and large medical expenses. But, for most other reasons, the penalty will be assessed. So look at your retirement account as the account of last resort, at least until you turn 59 ½ years old.
Mistake #5 – Taking Distributions in a Down Market
In essence there are two ways for the balance on your retirement account to decrease. When you take distributions and when the investments in your IRA lose value. If this happens at the same time, it adds to the difficulty of your account lasting as long as you need it. We sometimes call this sequence risk which means, account withdrawals during a down market are more costly than the same withdrawals in an up market.
Now it may be tough to know when the next down market will happen, but there are ways to plan in order to lessen this potential risk. If you are taking systematic withdrawals, such as monthly, you may want to have 6 – 12 months of distributions in a money market vehicle to avoid the need to sell in a down market. You can replenish the money market when your investments have turned positive. If you don’t necessarily need the funds right away, you could delay the withdrawal until a more opportune time in the market.
Mistake #6 – Withdrawing Too Much
There have been numerous studies done in order to determine a safe withdrawal rate on retirement accounts, so you don’t outlive your money. These are general rules of thumb, but the range is anywhere from 2.5% – 5% of the account balance on an annual basis. And this is heavily dependent on your age, your other sources of income, the rate of return on your investments, and the amount, if any, you would like to pass on to someone else.
The higher your withdrawal rate, the lower your chances for a successful retirement. This may force you to be more aggressive with your investments, lower your expenses, or potentially have to go back to work. Knowing a “safe” withdrawal rate can help in the development of your retirement saving strategy today.
In this blog post, we have covered six of the common IRA mistakes you want to avoid. Our next blog post will address six more. We can help you create a plan designed to avoid these mistakes. Call us today for a free, no obligation consultation. At Connections Financial Advisors, we work with our clients to better prepare them for their financial future in a friendly, educational way. You can reach us at (217) 605-8130.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
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