What to Watch Out For With IRA’s

IRA TricksIt’s not difficult to make a mistake with an IRA.  Although there are a few circumstances in which the IRS will make allowances for errors that were beyond your control, generally the rules around IRAs are pretty strict.  It’s best to be sure that you know what you’re doing; certain IRA-related errors can be a headache to fix (if they can be fixed at all).

Blunder Number One – Not Keeping Your Beneficiaries Current

Have you had a change of marital status?  Has your family grown in the last few years?  Have your financial circumstances changed significantly since the last time you checked your beneficiary designations?  If so, check to make sure that the beneficiaries you’ve listed accurately reflect your wishes.  You should also do this for any other retirement plans you have.

Blunder Number Two – Forgetting the Contribution Limit

You may not make an IRA contribution greater than your annual compensation (or your spouse’s if you’re making a spousal IRA contribution).  For the 2008 tax year, the maximum contribution for both traditional and Roth IRAs is $5,000.  If you have reached the age of 50 before or during this year, you’re eligible to add another $1,000.  If you make a contribution larger than you’re entitled to and you fail to correct the error before the due date for your tax return (including extensions), the IRS applies a 6% penalty to the excess contribution in each year that the excess amount remains in the account.

Blunder Number Three – Not Saving Some Of Your Economic Stimulus Rebate

You knew I’d work that in somehow, didn’t you?  Now that rebate checks are coming out, consider putting some of your check into your retirement savings, unless you’ve already maxed out.

Blunder Number Four – Ignoring Roth IRA Income Limits

If you make too much money you can’t make a contribution to a Roth IRA.  How much is too much?  A Modified Adjusted Gross Income (MAGI) of $114,000 for singles or $166,000 for married filing jointly put you over the limit for a Roth.  Between $101,000 and $116,000 (singles) or $159,000 and $169,000 (married filing jointly), your contribution is phased out.  Your MAGI is determined by taking your tax return AGI, subtracting any conversions, and adding back deductions taken for Traditional IRAs, student loan interest, tuition/fees, plus a handful of other deductions and exclusions.

Blunder Number Five – Fumbling an IRA Rollover

If you decide for some reason to rollover an IRA, be sure to do it carefully; an improperly-executed rollover will be treated by the IRS as a distribution.  If you’re under 59 1/2 and you withdraw funds from a traditional IRA, you run the risk of having to pay taxes on the withdrawal plus a 10% penalty.  If the funds are not put into another IRA within 60 days of withdrawal, you’re probably stuck – you must pay the taxes. Moreover, if this happens you can’t put the money back into an IRA.

The IRS may decide to waive this rule if it concludes that your failure to meet the deadline was beyond your reasonable control, but it’s easier to avoid the risk of penalties by making the transfer using a “trustee-to-trustee” rollover.  In this process, instead of receiving the funds yourself, they’re transferred directly from the old account to the new one.

Hasty IRA decisions often results in errors, so it’s a good idea to plan what you’re going to do before the end of the year.  IRA custodians are deluged with requests for transactions just as the tax deadlines approach, and sometimes they make mistakes.

Image by: Josh Thompson

About the author

Thomas Fisher, CFP®
Thomas Fisher, CFP®

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