An IRA offers a pretty easy way to build up enough money for a comfy retirement at home, out of state, or maybe on a beautiful island somewhere. And, you get some tax benefits in the process.
But an individual retirement account -- or arrangement, if you want to get technical -- isn't foolproof. There are pitfalls that can cost you thousands in penalties or lost earnings.
Avoid these common and potentially very costly IRA errors.
1. Not contributing enough
To receive the maximum benefit from your retirement account — the biggest possible nest egg, grown through investments — you want to put the maximum amount into your account each year.
The 2019 limit on IRA contributions is $6,000, or $7,000 if you're 50 or older.
With a traditional IRA, you contribute pre-tax dollars from your pay, and you may be able to deduct the amounts from your taxes, too. Your withdrawals in retirement are taxed as ordinary income.
With a Roth IRA, contributions get no tax breaks, but withdrawals are tax-free.
2. Contributing too much
Funding your IRA is like the bidding on The Price Is Right: You want to hit your contribution limit without going over.
If you exceed the threshold in any year, it can be almost as bad as going home from a game show empty-handed, without the new dinette set.
The IRS will charge you a 6% penalty tax on the excess amount for each year that it remains in your IRA, until you've either removed it or have reduced a future contribution to compensate.
3. Touching the money too early
Raiding your IRA too soon can get very expensive. If you're younger than age 59 1/2 and you withdraw investment earnings from a Roth IRA or any money from a traditional IRA, you'll owe taxes — plus a 10% penalty. (Ouch!)
So, if you seriously need money, think very carefully about whether it would be worth it to tap your IRA.
Note that there are several exceptions to the early withdrawal penalty. You might not have to pay it if you're disabled, have high out-of-pocket medical expenses, want to use the money for higher education, or are buying your first home.
4. Not knowing what's in your IRA
Though an IRA is considered an "account" and the purpose is to save for your retirement, it's not like a savings account. It's more of an investment account.
Your IRA might include mutual funds, CDs, stocks, bonds and possibly some real estate investments.
Don't be completely clueless about what's in there. You want to know, for example, that the mix is right for your age. The closer to retirement you are, the less exposure you want to riskier investments, like stocks.
5. Not contributing if it's not deductible
You may not be able to get a tax deduction for the money you put into a traditional IRA if your income is too high or if you also have a 401(k) or other retirement plan through work.
But it's a big mistake to choose not to contribute to your IRA if you're ineligible for a deduction.
Even without the write-off, you still have the opportunity to grow your money and defer paying taxes on it until you're retired — when you're likely to be in a lower tax bracket.
6. Missing out on a spousal IRA
If you have a job but your spouse is staying home taking care of the kids or just taking a break from work, the two of you might assume your spouse can't keep up an IRA. No income, no IRA — right?
Wrong. In fact, you can make contributions into an IRA on your spouse's behalf. You can pour money into your own account up to the annual limit, and then do the same with the spousal IRA.
It's a way to double your retirement savings as a couple during a time when one of you isn't earning a paycheck.
7. Botching your required withdrawals
A traditional IRA comes with a staggered expiration, and leaving money in the account too long can be even worse than cracking it open too early.
Once you reach age 70 1/2, you must start taking yearly "required minimum distributions," or RMDs. Calculating how much you need to shake out of your account each year is tricky, but the IRS has worksheets to help.
Hey, it's your money — so start enjoying it. Or else. If you don't take your RMDs at all or you don't withdraw enough, you may have to pay a hefty 50% excise tax on whatever amount you didn't pull out as required.
8. Not naming or updating beneficiaries
What will happen to the money in your IRA if something happens to you? If you don't designate a beneficiary or beneficiaries for your account, your heirs are likely to face delays and a tax hit on the way to getting the proceeds.
If you did fill in your beneficiary information, make sure to keep it up to date — especially after a major life change.
Don't assume that a divorce will keep your ex from receiving your IRA money. An ex-spouse can still inherit the account unless you've gone in and removed the name.
9. Procrastinating with contributions
Many retirement savers wait to make their annual IRA contribution until the very last second before the yearly IRA cut-off, which coincides with the April tax deadline.
Down-to-the-wire investments have less time to compound, which means you can potentially lose out on a decent amount of earnings over time.
If you don't have the full amount to put in at the start of the year and don't trust yourself not to wait until the last minute, consider setting up an auto-invest plan that will fund your IRA in fixed installments over the course of the year.
10. Not contributing later in life
With traditional IRAs, that odd age of 70 1/2 isn't only a time for mandatory withdrawals, but it's also the point when you must stop putting any new money into your account.
But Roth IRAs are different. With a Roth, you can keep making contributions no matter how old you are.
Why would you want to go on socking away more retirement money? Maybe you don't need it for your retirement but want to pass on a nice inheritance. Your heirs will be able to make withdrawals tax-free.
11. Putting your IRA on hold
If your car is starting to give out, you're worried about your job, or you see other potential financial needs on the horizon, it might be tempting to hit "pause" on your IRA contributions.
But that can be a serious mistake. Won't there always be something? Some excuse not to save? And before long, you'll have gone months or years without putting aside money that can seriously grow.
With a traditional IRA, an emergency that comes up might qualify for an exemption from the early withdrawal penalty. And if you've got a Roth IRA, you can make penalty-free withdrawals of your contributions (though not the earnings) at any time.
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