While individual retirement accounts (IRAs) are beloved by many investors, they do come with many complexities that—if ignored—can prove very costly. With this in mind, here are some common mistakes you’ll want to avoid making with respect to your IRA.

Not knowing the difference between a Roth and traditional IRA

There are several types of IRAs that all work a little differently, especially when examining each one from a tax perspective and developing an income strategy for your retirement.

If you need a refresher on the differences between a traditional and Roth IRA, keep reading. If you don’t, feel free to skip ahead to the next section.

A traditional IRA is a tax-deferred account, meaning you pay taxes on a future date. Therefore, any contributions you make are typically funded with pre-tax dollars and earnings grow tax-deferred until you withdraw them in retirement. 

With a Roth IRA, you make contributions using after-tax money. From there, your money can grow tax-free and you won’t pay taxes on withdrawals you make during retirement—assuming the account is at least five years old.

Take money out too early

With Roth IRAs, you can withdraw sums equivalent to the amount you contributed at any time, for any reason, tax-free, and without penalty—even before the age of 59½. However, if you want to withdraw from the earnings or profit portion of your account and you’re younger than 59½, you’ll incur a 10% early withdrawal penalty and pay taxes on these earnings (there are exceptions, which you can read about here).

If you make an early withdrawal (before age 59½) from your traditional IRA, you’ll not only pay income tax on that amount but will also incur a 10% penalty on the same. As with Roth IRAs, there are exceptions.

Not saving enough or contributing too much

For 2023, the IRS will allow you to contribute up to $6,500 annually to your Roth or traditional IRA. This maximum contribution amount is for all your IRAs combined—not per account. How much you should save depends on your specific financial situation, but IRAs generally represent a solid retirement savings strategy.

Alternatively, know that if you end up contributing more than this amount (perhaps you were awarded a pay increase or funding multiple IRAs), you could face a 6% penalty on the excess until you fix your error.

Not taking advantage of catch-up contributions

If you’re at least 50 years of age, the IRS allows you to make contributions above standard limits to your 401(k) and IRAs—referred to as “catch-up contributions.”

For 2023, these limits are an additional $7,500 per year for your 401(k) and $1,000 for your IRA: or a total of $8,500 if you have both accounts.

If it makes sense in your overall plan, you should take advantage of these benefits. Even if you save an extra $3,000 a year ($250 a month) for 15 years and average a 4% return, for example, you’d accumulate more than $61,000 in additional savings for retirement.

Not updating beneficiaries

Throughout the course of your life, you’ll likely experience various life events such as marriage, divorce, and/or the death of a loved one. In any of these cases, you’ll need to review the beneficiaries on your IRA—which is especially important because these will supersede anyone named in your will.

Not knowing the difference between a direct and indirect rollover

If you change jobs and want to roll over your 401(k) into an IRA or transfer funds from a traditional IRA into a Roth IRA (also known as a Roth conversion), be sure to familiarize yourself with key differences between a direct and indirect rollover.

A direct rollover is the simplest and oft-recommended way to move retirement money. With this option, your 401(k) or IRA administrator sends funds directly to your new IRA account without any need for you to touch the money.

With an indirect rollover—also known as a “60-day rollover”—you take physical custody of the funds with a check provided for you to deposit. In this scenario, you can use the money for any purpose for 60 days. However, you’ll need to redeposit the funds into a new IRA by the end of the 60-day period to avoid paying income tax and a 10% early withdrawal penalty (assuming you are under the age of 59½)—which is why indirect rollovers are usually only recommended if you need to urgently use the money and can execute this transaction within a 60-day window in the absence of risk.

Not contributing to your non-working spouse

The IRS allows a working spouse to make IRA contributions on behalf of a marriage partner who brings in no (or very modest) income: a provision known as a “spousal IRA.”

This isn’t a special type of account and is instead just your typical Roth or traditional IRA that’s subject to identical contribution limits, income limits, catch-up contributions, and other rules. The sole difference lies in the fact that your non-working spouse opens a spousal IRA in his or her name and there are a few distinct eligibility requirements you can read about here.

Not withdrawing money from an inherited IRA

Generally speaking, designated inherited IRA beneficiaries must follow the ten-year rule that states one must liquidate the account by the end of the 10th year following the IRA owner’s year of death. After the 10th year, any remaining account funds must be withdrawn and the account closed. During the ten years, beneficiaries can take distributions of any amount and at any frequency. Know that a failure to withdraw the money within the mandated timeline can result in a significant IRS penalty of up to 50% of the funds marked for withdrawal.

Forgetting about RMDs

Required minimum distributions (RMDs) are the minimum amount of money one must withdraw from a specific tax-deferred retirement account—such as a traditional IRA—beginning at age 72 (if you turned 70½ on or after January 1, 2020).

You must take your first RMD no later than April 1 the year after reaching the required age. For example, if you turned 72 in 2023, you’d need to do this by April 1, 2024. For all subsequent years, you must take your RMD by December 31.

A failure to take the full amount of your RMD by the required deadline could result in a hefty penalty summoning a 50% tax on the amount not withdrawn.

In sum: avoiding IRA mistakes

Currently contributing to an IRA? You’re probably off to a good start! However, you can do even better by avoiding the common IRA mistakes discussed in this article. Be sure to reevaluate your approach and make any necessary changes, accordingly!

Want to make sure you’re getting the most out of your IRA? Schedule a FREE Discovery call with one of our CFP® professionals.

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Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.

Disclosures:
This document is a summary only and is not intended to provide specific advice or recommendations for any individual or business. All examples are hypothetical and are not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.