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Seven Mistakes to Avoid with Your IRA Thumbnail

Seven Mistakes to Avoid with Your IRA

Make the wrong mistake with your IRA and it can cost you thousands. Here are the seven top mistakes to avoid.

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Full Transcript below:

Speaker 1 (00:07):

And welcome back to 30 Minute Money, the podcast that delivers action oriented smart money ideas and bite-sized pieces. I'm Scott Fitzgerald from Roc Vox Recording and production. Steve Wershing joining me in studio. Hey Scott. Thank you for joining me on your show.

Speaker 2 (00:25):

Yeah, whatever. It's nice to be here on my show.

Speaker 1 (00:31):

So one of the things that we like to talk about are mistakes on this podcast.

Speaker 2 (00:35):

Yeah. We love to talk about mistakes.

Speaker 1 (00:36):

Mistakes. And so you brought seven with you this time.

Speaker 2 (00:40):

I brought seven to seven mistakes that you can make in funding your I R A or managing your I R A. So that's what we wanted to talk about today is avoid these seven mistakes so you don't deplete your I R A more than you need to, right? Or not fund it as much as you need to. So that's what we wanted to talk about. So the first thing I want to mention is a mistake that you can make is missing your catchup provisions. So if you are over 50, you can actually put more in your I R A than you could below 50. So there's a little extra spiff that you can put away. So miss your ketchup, it doesn't cut the mustard. So we want to make sure you do that. So, hey, and this is not just IRAs, this is all retirement plans.


So for 4 0 1 Ks you can put in, they've actually raised the ketchup provision. So before it was you could put an extra $6,500 away. If you're over 50 now you can put $7,500 more away. So into your 4 0 1 K, you could put as much as $30,000. Wow. I know, right? One of the challenges is if you wait until later to really get serious about retirement and the kids are out of school and you're really just focused on that retirement goal, we call that sort of the red zone, the retirement red zone, that's when people get really serious. Well, you can't make a whole lot of progress if you're just putting six, $7,000 a year away, which is what you could do directly into an I R A. So really if you want to get serious about it, a lot of this stuff is going to happen in your retirement plan at work in your 4 0 1 K. And so maximizing those catch up provisions will help you put a lot away. Like I said, now you can put $30,000 into your 4 0 1 K if you're over 50. So that's one thing, miss that opportunity and you're going to have a whole lot less in your I R A ultimately than if you took advantage of it. So mistake number one is don't miss using the catch up provision.


Mistake number two is not making contributions. If you are above the threshold where you can make a deductible contribution. So you can put money away into an I R A and as long as you have earned income, and especially if you're not participating in a qualified retirement plan, you can put money into an I R A and you can deduct it from your taxes and some people, but up to a certain point above that point, you can't deduct it anymore. And some people just stop contributing when they get over that point. My suggestion is continue to put it away even if you can't deduct it. So make a non-deductible contribution. There is no upper threshold on that as long as you've got the earned income, you can put money into an I R A. It just may not be deductible, but that's okay. Non-deductible contributions are still valuable.


One thing is that's the basis of the strategy that we call a backdoor Roth contribution. So if you make above a certain threshold of money, you can't put money into a Roth I R A, but you can put money into an I R A that you don't deduct, and then you put the money into the I R A without deducting it, wait a little while and then convert it into a Roth. The conversion would typically be taxable. But if you haven't taken a tax deduction for the I R A and it hasn't grown a whole lot when you do the conversion, there's really very little that they can tax you on. So it essentially is making contributions to a non-deductible. I R A gives you another avenue for putting money into a Roth I R A that you may not have been able to do before.


One little tip, if you're going to put money into A I R A without deducting it, my suggestion is you keep it separate from other IRAs because if you have deductible and non-deductible contributions into the same I R A doing the accounting when it comes back out is gets messy. Really complicated. So much better. If you're going to put money into an IRA and it's not going to be deductible, open a different I R A and do it. You can have as many IRAs as you want to and just, it really simplifies the bookkeeping if you can keep those traditional and non-deductible IRAs kind of separate.


Another one that some people miss sometimes is the mistake of not contributing to a spousal I r A. So the typical rules for IRAs are that you can put money into it as long as you have earned income, and there are limits within that. But the key is you have to have earned income. Well, if you have a spouse who is not working outside the home, some people just miss that when they're doing their retirement plan contributions. But if you're married and you file your taxes jointly, you can put money into an IRA for a spouse even if that spouse is not working. And that's another six, $7,000 that you can put away each year that you would miss otherwise. So just keep in mind, you need to be married filing jointly to do it, but if you do that, you can put money into an own I R A for a non-working spouse, and that would be another good way of putting a few thousand dollars away. I

Speaker 1 (06:05):

Can't imagine filing separately with,

Speaker 2 (06:10):

Yeah, most of the time you pay more tax, but there can be some good reasons for doing it. Yeah, I mean the two big ones that come to mind are, one is if you've got student debt and you're on an income-based repayment plan, filing separately means that your spouse's income is not included in how you calculate what you have to pay back on your student loans. And if, for example, you're working on the public service loan forgiveness program, so you're working in a nonprofit and so after 10 years, whatever you have left is forgiven, you want to keep those payments as low as possible. You want to keep the balance actually as high as possible because that will maximize the forgiveness. So that's one reason for doing another reason is in fact, I'm working with some clients now who, it's a married couple, they want to retire.


She's not 65 yet. And so when she retire, so he's over 65 and retired, so he's on Medicare. When she retires, she's going to have to buy her own health insurance and if you buy it from the New York Exchange, and then they will test your income to see if you qualify for a subsidy. So where health insurance would be very expensive, if you file separately, they will just look at your own taxable income. And if you're retired, not making very much in retirement, not filed for social security yet, you get a lot of subsidy for the health insurance. So there are some reasons why you might so

Speaker 1 (07:34):

Much to learn on this podcast.

Speaker 2 (07:36):

I know, right?

Speaker 1 (07:36):

It's mind boggling.

Speaker 2 (07:37):

Yeah, it's ridiculous. So yeah, so it's unusual. It's not the standard case, but there can be reasons why you might, even if you have to pay a little more tax, there may be good reasons to file separately. So getting back to the IRAs. So we talked a little bit about funding IRAs. Let's talk about moving money from qualified plans from your 4 0 1 K or 4 0 3 B or something like that into your I R A. One of the biggest mistakes that you can make if you leave an employer is not rolling over your qualified plan into an I R A. There was a study done within the past year, Wang, Zion Lynch, and what they found out was that 41.4% and this number is scarily consistent. It's frightening how consistent, because I remember 10, 15 years ago we were talking about the same 40%. 41% of people cashed out their 4 0 1 k did not put it into a retirement plan.


They cashed it out, paid the tax on it, went into the rest of their accounts. That's a mistake that you really can't recover from. All you can do is sort of start over again at that point. So don't make the mistake of not rolling it over. Bank rate. Just did a survey a little while ago that found that 51% of survey respondents took premature withdrawals from their retirement plan, whether that be a 4 0 1 K or an I R A. Again, tapping into stuff that's earmarked for later makes it a lot harder to have what you need when you get to that point. I

Speaker 1 (09:20):

Wish I didn't. I had a 4 0 1 K back in the day and I broke it because of a lot of things that were going on. It wasn't a whole lot, it was like four or $5,000, but that was in 98 or 99. So if it was still in there,

Speaker 2 (09:36):

It would be a lot more than that now. It would be would be. And the challenge is things come up, right? I mean, if you lost your job as opposed to left your job, I mean you might need money. And I get that. I totally understand. There are other things that you can potentially do. Just keep in mind if you pull money out of a retirement plan like that, you're going to pay federal income tax, you're going to pay state income tax and if you're under 59, you're going to pay a penalty, excise tax on top of it. So we're talking 50% of that is going away and so are, even if you borrowed money on the highest paying credit card or highest cost credit card, you could find it's only half that cost. I understand things come up and you may need money. Let's examine where else you might be able to get some funds from rather than pulling it out of retirement plan prematurely. Oh

Speaker 1 (10:31):

Yeah. I'm sure that if I would've actually hunkered down and had someone guide me through and talked about it, we could have found another way.

Speaker 2 (10:41):

And if you can't find a way to solve the whole problem, you can solve part of the problem, right? Just work on trimming that. So not rolling over 4 0 1 K Ss is a huge problem. Sort of related to that is making ineligible rollovers. So there's some kind of money that you can't roll over and if you do a rollover with money that doesn't work, that can't be rolled over, you have another special tax called an excess contribution tax because what went into that I R A wasn't supposed to go into that i r A that gets taxed to. So if for example, you're taking a required minimum distribution, can't roll that into an I R A, you have to take that as taxable money. It has to stay outside the retirement plan environment. Sorry. If you try to roll over part of a required minimum distribution, it's an excess contribution.


When they catch up with you, there's an excise tax on that, so you'll have to pull it out and you'll have to pay a tax on it. And then there's another one that we'll talk about in a minute, but that is money that you got into your hot little hands and did not put it back into a corporate plan. And you did not put it into an I R A within 60 days. If you take money from a retirement plan, you have 60 days to put it into the I R A and if you miss it, it's fully taxable. If you try to put it back in on the 64th day, it's an excess contribution. So not only will you have all the taxes due on the money that could have been rolled over, you've got another tax to pay by making an excess contribution because after the 60th day, not going to happen anymore.


So be careful of what you roll over because if it's ineligible, then there will be more taxes. But number six, it much bigger. One is, and this is one that surprises people, and this is one that can be tricky, making more than one rollover within 12 months. So you're allowed to do rollovers, but you're limited to doing one rollover per 12 months. So let me give you a story about when that went horribly wrong. Somebody left his job and rolled over the 4 0 1 K into the I R A that was cool and then had a real opportunity, I believe it was sale of a house. So he was selling a house, buying a new one, the new one was going to close before the old one could close. So he needed money to bring to closing to close on the house. And so he knew that there is this rule that you can work it such that you can take money out of an i R a and you've got 60 days to do something with it and then put it back in.


And so now the i r s frowns on that, there's something called constructive receipt where this is why you can't borrow against, borrow against an I R A. You can borrow against a brokerage account, but you can't borrow against an I R A because that means you've effectively used the money, you didn't spend the money, but you utilized it. And that is as good as receiving it. So that would make it taxable anyway. But there's this little loophole with the 60 day rule where if you say, I'm going to move this money from this I r A over here to that I r a over there, and I'm just going to take it out of this one, get it in my hot little hands and then I'm going to put it into this one over there. You got 60 days to do that. In the meantime, if you happen to use that money and the I r s doesn't find out, okay, well, so that can work out okay.


You've got to be hyper-focused on that 60 day window like we were just talking about because if you miss 60 days, the whole thing is taxable. But here's where this guy got caught, left his job, rolled over his 4 0 1 K into his I R A, took the money out of the I R A, used it to close on his new house, old house settled. He got the money, put that money into the new I R A. Well, within 60 days, no problem, right? No, I'm waiting because it was the second rollover that he did in 12 months. He took the money, he rolled the money from his 4 0 1 K to his I R A when he took the money from one I R A and put it into the other I R A. That was a second rollover, disqualified, tens of thousands of dollars in tax, lost all that money, lost the ability, and he thought he was playing the system. He thought he was so smart like I got this. But that's one of those things you got to be really careful about is that one rollover within 12 months rule. That's one that is easy to make a mistake on.


One way of avoiding that is that whenever you move money from one retirement account to another, make sure it's a trustee to trustee transfer if it never gets into your hands, there's a difference between an I R A rollover and an I R A transfer. So let's say you left the job, moved the money from the 4 0 1 K into an I R A and let's say the i o is at Fidelity, and then you decided you didn't like Fidelity and so you wanted to move it to Vanguard. So you transferred the I R A to Vanguard, no problem. And then you decided you didn't like Vanguard. So you're going to transfer the I R A to another institution to TD Ameritrade or Schwab or something like that. No problem, because transfers are not the same as rollovers. And so as long as you, when you're moving money, if you keep it as transfers, you're a lot safer and make sure that you're doing it as trustee to trustee.


If it gets into your hands and you put it into an I R A, it's a rollover. So one way to protect yourself, I mean, it's still not going to be, you can still end up doing more than one rollover in a year, even if it goes trustee to trustee. But if you keep a trustee to trustee, that's one level of protection. So just keep your hands off the cash. Try very if you're going to be clever and use one of those strategies. Okay? Just make sure you're working with somebody who knows all the rules because it's a complicated machine. There are a lot of gears in this box, and if you miss one of those things, then it can cost you a lot. And then the final one, the seventh mistake that you can make with an I R A is rolling over after tax contributions from a 4 0 1 K to a traditional I R A.


So you can make non-deductible contributions into a 4 0 1 K, especially since the secure Act 2.0, which we've jokingly referred to here before as Roth application of Everything ACT Doing after tax contributions to retirement plans is going to get more and more popular, and it can be a great idea, it can be a great tax planning strategy. You just have to be careful that when you leave that employer and you roll the money out of the company, you do a split roll. So the money comes out, but it goes to two different places. The traditional monies goes to a traditional I R A. The after tax money goes to a Roth I r A. You could take some of that non-deductible 4 0 1 K contribution in cash, but if you want to keep it in the retirement plan environment better to move it into a Roth, you build up your tax free bucket. Just don't take, if you've got one of those 4 0 1 KSS that has pre-tax and after tax contributions and it just make sure you don't roll the whole thing over into a traditional I R A because the non-taxable part of that is not eligible for a traditional I R A. So you'll end up with an excess contribution, pay a penalty on that.


So again, the lesson here is when it comes to a lot of these things, there are a lot of i r s rules. There are a lot of things that you got to pay attention to. Be careful. Consider working with somebody who knows the different rules and can map out a specific strategy that you're thinking about. Make sure you don't run into any problems.

Speaker 3 (19:21):

Your retirement is at risk, not from the stock market, not from inflation. Taxes are putting your retirement at risk. I'm certified financial planner, Steve Waring and I specialize in helping people create low tax retirements. Unmanaged taxes can take 30, 40, even 50% of your retirement income. Learn how to defend yourself against excess taxation. Our complimentary webinar will cover all the principles you need to know to protect your money for you and your family, and keep it away from the government. This free webinar will cover how taxes are different in retirement, the taxes you pay in retirement that you don't have to pay during your working life, how to move savings into a tax-free environment. The Widow's Tax, the Secure Act, the Secure Act 2.0 and what they mean to you. The webinar is free, but you have to register to save your spot. So go to focused wealth advisors.com/webinars and find out more and sign up right there. Even if you're not planning to retire for the next five or 10 years, this information will be critical for you. The longer you have to put the strategies into effect, the more you can accomplish. That's focused wealth advisors.com/webinars to find out more and to sign up today.

Speaker 2 (20:47):


Speaker 1 (20:47):

Right, seven big mistakes. What's your 30 minute action item?

Speaker 2 (20:50):

30 minute action item is map out what retirement accounts you might need to pull money out of next year, and write out the strategy for where it's going to go.

Speaker 1 (21:00):

30 minute money, three zero minute.money is where you can find the podcast. I'm Scott Fitzgerald from Roc Vox Recording and production with Steve Wershing of Focused Wealth Advisors. We will catch you next time on 30 Minute Money. Thanks for listening and watching.