Commentary by Adam Cmejla
The Individual Retirement Account is the Titanic of most peoples’ retirement plan — it typically tends to be their biggest asset at retirement. But there are a number of issues that can occur that are not advantageous to investors if proper planning and monitoring are not done.
Let’s highlight five areas where we’ve seen mistakes occur:
Not taking your required minimum distribution
The IRS requires you to start taking out a portion of your IRA each year after you turn 70.5, even if you don’t need the money. During the year in which you turn 70.5, you have up until April 15th of the following year to make that distribution, but keep in mind that you will have to make two distributions that year: the one for the year in which you turned 70.5, and then another one before year’s end for that calendar year. If you forget, the penalty is pretty steep: the IRS will assess a 50 percent penalty on required distributions that were not taken.
Many people think that because they have a will in place that they do not need to name beneficiaries on their IRA’s. However, it’s important to remember that any beneficiary information that is on file with your IRA custodian will supersede any bequests you have listed in your will. This is especially important if you’ve had a death or change in marital status due to a divorce. Make sure all of your IRA accounts reflect your final wishes, including any charitable giving you want to make. A good estate attorney will help you direct how to properly title your retirement accounts to reflect your estate wishes.
Not knowing how to ‘stretch’ an IRA
Unless you are the spouse of someone that’s passed away, the IRS will require you to make required minimum distributions from an IRA that you’ve inherited. Depending on the age of the person when they passed away, you may be able to “stretch” those distributions over your lifetime, thus potentially preserving significantly longer the value of the assets in the account.
Forgetting about after-tax dollars in an IRA
If you’ve made non-deductible contributions to an IRA in the past and therefore have basis in the account, it is important to track that basis. This is done by filing Form 8606 with your tax returns. Failing to file this form means the IRS views 100 percent of your IRA as deductible contributions, thus 100 percent of your distributions will be taxable. This, in its essence, is double taxation.
Improper Roth conversions or recharacterizations of Roth IRAs
If you’ve converted Traditional IRAs to Roth IRAs and it is deemed a “failed conversion,” the IRS generally views the failed conversion as a total distribution from the Traditional IRA, thus causing a taxable event in the year it was performed. Obviously this can have some major tax implications given the changes in the tax code. If you’ve properly converted a Roth IRA, need to “recharacterize” that conversion (for any number of reasons that won’t be discussed here), and that recharacterization is done improperly, you could also open yourself up to adverse tax consequences.
Adam Cmejla, CMFC® is President of Integrated Planning & Wealth Management, a comprehensive financial services firm located in Carmel providing comprehensive retirement planning strategies to individuals near or in retirement. He can be reached at 853-6777 or firstname.lastname@example.org.