IRA Missteps to Avoid

Article Highlights:

Selecting a Type of IRA
Missing out on the Saver’s Credit
Taking Distributions before Retirement Age
Failure to Keep Designated Beneficiaries Current
Overlooking the Spousal IRA
Failing to Recognize Low Tax Distribution Opportunities
Social Security Income and Traditional IRA Distributions
Rollover Errors
Failing to Take a Required Minimum Distribution
Knowing the Beneficiary Options
Understanding the Special Spousal Beneficiary Options
Disclaiming an Inherited IRA
Failing to Realize Your Child Can Have an IRA
Not Taking Advantage of IRA-to-Charity Distributions

If you have an IRA account or are considering one, there are a number of potential missteps you will want to avoid. Some of them can lead to unwanted taxes and penalties, and of course, we are talking about your retirement funding, so it is an important issue. Here are a number of issues to keep in mind:

Selecting a Type of IRA Account – The first decision you will have to make is whether to choose a traditional IRA or a Roth IRA. A traditional IRA provides a tax deduction for the contribution and tax-deferred growth, but any withdrawal from the account is fully taxable. On the other hand, Roth IRA contributions are not deductible, but distributions after retirement are tax-free. A Roth IRA offers tax-free accumulation, meaning the earnings build up over the life of the IRA tax-free. Making the decision involves a number of factors, some of which will be discussed later in this article.

For those currently with low income and on a limited budget with little extra income to spare for IRA contributions, the traditional IRA offers a tax deduction, which will allow them to make a larger contribution and is better than having no retirement funds at all. In addition, lower-income individuals may qualify for the Saver’s Credit, discussed later, which provides a tax credit that might help them to afford a contribution.

For younger individuals, a Roth IRA provides tax-free accumulation, meaning the earnings will be tax-free when distributed at retirement. Thus, the longer one has a Roth IRA, the more tax-free income it can provide.

Missing out on the Saver’s Credit – As mentioned previously, the Saver’s Credit helps lower-income individuals to save for retirement by providing a credit to help cover the cost of their IRA contribution. The credit can be as much as 50% of the first $2,000 contributed to an IRA (either traditional or Roth), depending upon your income for the year. It is not allowed for individuals under the age of 18, individuals claimed as dependents of another or full-time students. The credit is non-refundable, meaning it can only be used to offset one’s tax liability, so lower-income taxpayers may not have enough tax to benefit.

Taking Distributions before Retirement Age – If a distribution is taken from a traditional IRA before reaching the age of 59½, that distribution will not only be taxable but will also be subject to a 10% early withdrawal penalty. So, consider it carefully before taking an early distribution. Assuming you are in the 22% tax bracket, every $100 of an early distribution will result in you owing $32 of tax, including the penalty. Only take an early distribution if you are desperate. There are exceptions to the 10% early withdrawal penalty, but not for the tax on the early distributions. The common penalty exceptions include limited withdrawals for a home pu