An IRA offers a straightforward method to accumulate savings for a relaxed retirement, whether that’s locally, in a different state, or perhaps on a picturesque island. Plus, you enjoy tax advantages along the way.
While there are potential drawbacks to using an individual retirement account (IRA), it’s important to keep in mind that it’s a valuable tool for retirement savings. By knowing the potential pitfalls and taking steps to minimize them, investors can make the most of this valuable resource. Missteps can result in significant penalties or missed financial gains.
Steer clear of these typical and potentially expensive IRA blunders:
#1 Under-contributing
Maximizing your contribution to your IRA annually ensures you get the most out of it. For 2024, the contribution cap was $6,500 or $7,500 if you’re 50 or older.
Traditional IRAs involve contributing pre-tax income. You might even deduct these contributions from your taxable income. Yet, when you withdraw during retirement, it’s taxed. Conversely, Roth IRAs don’t offer tax deductions for contributions, but the withdrawals are tax-free.
#2 Over-contributing
It’s essential to contribute up to, but not beyond, your IRA’s limit. Overstepping can result in a 6% tax penalty on the surplus amount for every year it stays in the IRA unless adjusted.
#3 Premature Withdrawals
Withdrawing from your IRA before age 59 1/2 can be costly. Early withdrawals from a traditional IRA entail taxes and a 10% penalty. But there are exceptions like disability, significant medical expenses, higher education costs, or purchasing your first house.
#4 Being Unaware of IRA Contents
Your IRA isn’t just a savings pot. It’s more like an investment portfolio containing mutual funds, stocks, bonds, and possibly real estate. It’s crucial to ensure your investment mix aligns with your age and risk tolerance.
#5 Skipping Non-deductible Contributions
You might not qualify for tax deductions for your IRA contributions under certain conditions (income is too high or if you also have a 401(k) or other retirement plan through work). Yet, not contributing is a mistake. Your money can still grow tax-deferred until retirement.
#6 Overlooking Spousal IRA
If your spouse isn’t earning, you might assume they can’t have an IRA. This isn’t true. You can contribute to your IRA and also to a spousal IRA, doubling your retirement savings.
#7 Mismanaging Mandatory Withdrawals
From age 70 1/2, traditional IRAs mandate yearly “required minimum distributions” (RMDs). Not adhering to this rule can attract a hefty 50% tax on the undrawn amount.
#8 Neglecting Beneficiary Details
Ensuring you’ve named beneficiaries for your IRA is essential to prevent future hassles and tax implications for your heirs. And if circumstances change, updating this information is vital.
#9 Last-minute Contributions
Some people delay their annual IRA contributions until the tax deadline. Such late contributions have reduced compounding time, diminishing potential gains. To avoid this, consider automated periodic contributions throughout the year.
#10 Avoiding Late-life Contributions
While traditional IRAs prevent new contributions post 70 1/2, Roth IRAs don’t have such limits. Continuing contributions can be a way to provide tax-free inheritances to your successors.
#11 Pausing your IRA
Postponing IRA contributions due to unforeseen expenses can set you back significantly. With a traditional IRA, certain emergencies may qualify for an early withdrawal penalty exemption. With Roth IRAs, contributions (not earnings) can be withdrawn penalty-free at any time.