The biggest source of wealth for most Americans is their retirement accounts and much of that money is tucked away in Individual Retirement Accounts.
Roughly $7.4 trillion dollars is sitting in Individual Retirement Accounts, which exceeds the $6.8 trillion invested in workplace defined contribution plans such as 401(k) and 403(b) accounts.
With so much money invested in these IRA accounts, it’s important to avoid costly mistakes. Here are seven common pitfalls to avoid:
In 2016 you can contribute $5,500 to a Roth IRA or traditional IRA and, if you will be 50 or older during this calendar year, you can contribute an extra $1,000.
Older investors with a 401(k) as well as other workplace retirement accounts can also make catch-up contributions. Here are some catch-up contribution ceilings:
Catch-up Contributions for 2016
SIMPLE IRA $3,000
An opportunity exists for even greater catch-up contributions for 403(b) investors with at least 15 years of service.
A Roth IRA can be a great way to save for retirement. Unlike a traditional IRA or workplace plan, the money you invest in a Roth is after-tax dollars. Forgoing a tax break upfront allows you to withdraw money tax-free from a Roth during retirement. This benefit isn’t available for other types of IRAs.
One of the other beauties of a Roth IRA is that you don’t have to take required minimum distributions during your lifetime. If you don’t need the money, you can pass it along to a loved one when you die.
If you inherit a Roth IRA, however, you must take required minimum distributions. Failing to do so will trigger a 50% penalty on the missed required withdrawals. Mandatory distributions are also required for other inherited IRAs.
Don’t leave your IRAs to the wrong person. You probably wouldn’t want to bequeath your hard-earned money to your former spouse and you also would not want to intentionally stiff one of your kids or perhaps a grandchild. This can happen if you do not keep beneficiary forms current.
One reason why beneficiary forms aren’t updated is that people mistakenly assume that their wills direct who receives their IRAs. If your will says that your present spouse will inherit your IRA, for example, but your IRA beneficiary form still lists your former spouse, it’s the ex who will strike gold.
Failing to name a beneficiary or simply naming your estate as the future recipient of an IRA can also be a costly error. If you don’t name a beneficiary, the default beneficiary will typically be your estate. This is a good way to blow up an inherited IRA because the distribution will have to be made as a lump sum, which will pull the money out of its tax-protected cocoon, or will require the account to be emptied within five years of your death. Either of these events will trigger unwanted income taxes.
There is no limit on how many retirement accounts you can establish, but having an excessive amount will make it harder to keep track of your assets and more difficult to calculate required minimum distributions later on.