5 IRA Mistakes
Many savers and investors can make mistakes with their Individual Retirement Accounts (IRAs). Here are 5 common mistakes that a lot of people make:
1.) Unexpected Taxes - IRA Conversions - now that the income threshold has gone away to convert traditional IRAs to Roth IRAs, anyone can convert their regular IRA over to a Roth IRA. This includes non-deductible IRAs which are used when someone's income is too high to make a traditional contribution to a Roth IRA. The thresholds for 2013 are $127,000 for singles and $188,000 for married filing jointly.
What many people are doing in getting around this is to convert non-traditional IRAs over to Roth IRAs since they don't qualify for the Roth IRA because their income is too high. This backdoor approach works fine if these are the only IRA assets they own.
The problem arises when they have other deductible IRA assets they own. Essentially this is pre-tax money that has not been converted over yet and taxed on. When this happens, the IRS deems that one must determine the ratio of taxable versus nontaxable money in total which includes all IRA money. This triggers a partially taxable conversion when there are other deductible IRA assets which can come as a big surprise!
2.) Rolling over 401(k) plan with company stock - many people erroneously assume the best option to take is to roll their old company 401(k) plan over to their own individual IRA. In many cases this can be the best approach but not always especially when the 401(k) has company stock in it that was made with pre-tax contributions and employer matching contributions.
When this is the case, the IRS allows special tax treatment on the stock when it comes out of the plan. Essentially the stock is taxed at ordinary income rates on the cost basis of the shares but is only taxed at long term capital gains rates for any appreciation of the stock over and above the basis. By not rolling this old 401(k) plan over, you can get more favorable tax treatment of the assets when they come out versus what you could get if you rolled the assets over to your own Individual Retirement Account (IRA).
3.) Asset Location Tax Management - it makes sense as you get older to think about tax management for your investments - this usually entails putting the more tax inefficient assets - those that kick off a lot of income - into your tax-deferred accounts and your tax efficient assets into your taxable accounts. However many people can put too much focus on this and get carried away!
Some people think they should not own any stocks in their tax deferred accounts when they could be missing out on years of long term non-taxed appreciation. It really all depends on your own unique time horizon and situation.
4.) Required Minimum Distributions - when you turn 70 1/2 you are required to start taking a minimum distribution from your retirement accounts. What many people don't realize is they can take this RMD from just one account and are not required to take it equally across all their accounts.
As long as the accounts are the same type - ie - all IRAs - you can be selective about which account to take your RMD from. This means you can look at all your retirement accounts and determine where it makes the most sense to pull from. This can help in terms of reallocating your retirement accounts on a regular year end basis. Note that if the accounts are not like type - ie - IRA and 401(k) - RMD's must come from both separately.
5.) The 5 Year Roth Rule - the IRS imposes a minimum 5 years before someone can take assets out of a Roth IRA both tax and penalty free. Of course you can always take your contribution you put into the account out at any time without taxes or penalties but everything else is subject to this 5 year rule.
Where things get more complicated is when you convert traditional IRAs over to Roth IRAs as each conversion gets it own 5 year period. In order to avoid penalties, you have to be over 59 1/2 or 5 years must have lapsed since the conversion. Make sure you keep track of each conversion including the total amount and date of conversion so you can stay on top of this! Otherwise, you could be subject to distribution penalties.
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Are you looking for more information about this article on 5 IRA Mistakes? Would you like a second opinion on having someone go over your own unique retirement situation?
If so - please email me at carleton@mchenrycapital.com or call me at 888-968-9815 and I would be happy to tell you more and/or discuss your own situation in more detail.
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