Common Avoidable Mistakes in Running an IRA Savings Account

 

Overview of IRA Savings Accounts

An IRA savings account can be an essential part of a holistic retirement strategy. The tax benefits and investment options available with an IRA have made it a popular choice for many savers. Handling an IRA savings account is not always easy, and common mistakes lead to missed opportunities or very costly penalties. This blog discusses some of the most common pitfalls you should avoid when handling your IRA savings account to maximize the yields you can achieve from your retirement savings.

Not Maximizing Contributions

Many people make the critical mistake of not contributing the amount they're allowed to contribute to their IRA savings account. As good as it is to have any money in an IRA, you're losing the growth of that lost amount. In 2024, you can contribute as much as $6,500 to either a Traditional or Roth IRA. If you are 50 and older, you may contribute $7,500. This is an inflation-adjusted limit, so you want to keep track of any inflation adjustments.

To avoid this inconsideration, a nice strategy would be to take advantage of automatic contributions to your IRA. No matter how much you may not be able to contribute the maximum this year, steady contributions will add up over time and give you a big boost in retirement savings.

Not Planning a Roth Conversion

A Roth conversion would involve a rollover of funds from a Traditional IRA into a Roth IRA. While the incomes are increased for tax purposes in the year of the conversion, it allows one to withdraw the funds tax-free after retirement. Many people miss the chance to do a Roth conversion when their income is lower, which could be more advisable to help reduce taxes if taken out of the IRA later.

Knowing whether a conversion into a Roth is the right fit or not should be weighed with care because the process can be quite cumbersome in understanding the implications it will have on tax liability both now and well into the future.

Ignoring RMDs

Traditional IRA owners will start making RMDs once they reach age 73. If RMDs are ignored or forgotten to be taken, serious tax penalties abound. In case you fail to take an RMD, the penalty is as high as 25% of the amount not withdrawn. Therefore, it is very important to know the rules about RMDs and start your planning early enough. Mark the calendar or set reminders so that you don't miss the date. Other factors to include in this analysis are methods of mitigating tax effects on the distributions—perhaps spreading withdrawals or utilizing funds for qualified charitable distributions, which are nontaxable and could be used to satisfy RMDs.

Investing Too Conservatively

Probably the most common error associated with an IRA savings account is being overly conservative with investments. Although you absolutely must be cautious and protect your principal, getting too conservative, especially when you are relatively young, limits what your account can potentially grow into. With a long time horizon, most of your IRA probably resides in cash or low-yield bonds—simply translated, your retirement dollars won't keep pace with inflation.

Diversify your portfolio with an appropriate mix of stocks, bonds, and other investments in keeping with your comfort level for risk and time horizon to retirement. It's always wise to decrease risk as the time to retirement approaches, but having some growth products in the portfolio will also help extend its life so that inflation does not cause it to diminish.

Make Sure Beneficiary Designations are Up to Date

A critical component of establishing an IRA savings account is the selection of a beneficiary. Without such designation, your assets may face probate for several months, and your intended beneficiaries won't be able to access your savings. Furthermore, there are frequent cases where the names of beneficiaries are not updated subsequent to marital change, divorce, or birth of children and will, therefore, receive unintended benefits.

To avoid such an oversight, reviewing and updating your beneficiary designations regularly is called for, to ensure that your IRA assets pass on to whomever you would wish without unnecessary delays or legal complications.

Early Withdrawal

While the IRA savings account offers many tax advantages, it does have very stringent rules about early withdrawals. Taking money out of your IRA before age 59½ will generate a 10% penalty on top of the regular income tax for Traditional IRA distributions. While the new Roth IRAs allow considerably more flexible withdrawal of contributions—but not of earnings—this is, again, not particularly wise to tap into early as an access route for your retirement savings.

Tip: Use very limited availability of early withdrawals only in dire financial situations and know what other exceptions to the penalty there are, for instance in first-time home purchases or qualified education expenses. Knowing these rules will thus guide informed choices so as not to destroy your retirement nest egg.

Not Making Catch-Up Contributions

The IRS allows "catch-up" contributions for those 50 and older to boost retirement savings. The catch-up contribution limit for IRAs for 2024 is an extra $1,000. You probably will be forgoing a significant opportunity to enhance your savings in the years before retirement if you fail to take advantage of this provision.

Action Step: If you can contribute more, in that case, budget it and change your savings plan so as to take maximum advantage of the catch-up contribution benefit. The added push will hopefully make a deep difference over time in the retirement funds.

Roth IRA Income Limit Myth

Contributions to Roth IRAs are phased out by income limits, turning the promise of tax-free growth in these accounts into a trap for higher earners whose incomes increase in retirement. Because you must have a modified adjusted gross income below threshold levels to contribute to a Roth IRA in any year after the first year you contribute, these limits phase out or eliminate your ability to make those contributions once your MAGI exceeds them.

Solution: If you are not eligible to contribute directly to a Roth IRA, there is a strategy called the "backdoor Roth IRA" whereby you contribute to a Traditional IRA and then convert it to a Roth IRA. Such a backdoor strategy requires careful planning so that you may avoid unexpected tax consequences, thus it pays to speak with a tax professional.

Lack of Diversified Investments

You may expose your IRA savings to unnecessary risks by relying on a very narrow set of choices for your investments. It can be very tempting to continue putting your money in what you know or what had worked well in the past; however, the lack of diversification can really place your portfolio at risk.

Approach: To diversify across different asset classes such as stocks, bonds, mutual funds, ETFs, and possibly alternative investment via REITs or commodities for smoothing returns or perhaps to mitigate the side of market volatility.

Not Reviewing Your IRA Strategy Periodically

People tend to "set and forget" their IRA savings accounts. A long-term approach is wise, but one must not let years go by and thus end up missing opportunities or an investment strategy no longer in line with either their goals or risk tolerance.

Best Practice: Roll over your IRA savings account at least annually or after any major life event. This could be considered a review, which will enable you to rebalance the portfolio, update your investment choices if necessary, and ensure that your strategy remains appropriate for your retirement timeline.

Oversight on Potential Inheritor Benefits Under Roth IRA

Perhaps the least known is the Roth IRA's ability to provide inheritance benefits. Unlike traditional IRAs, all RMDs cease on a Roth IRA when the account owner dies. As a result, all the contributions continue growing tax-free. In addition, any funds can be withdrawn tax-free by the beneficiaries; thus, Roth IRAs are a highly effective way to make estate plans.

Estate Planning Tip: As you may have concerns with legacy, knowing the benefits of a Roth IRA is crucial to your beneficiaries as part of retirement planning. This strategy can ensure that your loved ones maximize their benefit from your hard-earned savings.

Conclusion

Managing an IRA savings account requires understanding all the different rules and strategies that come into play when managing your retirement savings. Having avoided pitfalls like low contributions, failure to withdraw RMDs, and maintaining investments too conservatively, you may end up maximizing your IRA savings account to retire comfortably. Should you stay informed of changes in the contributions and tax laws, and should you keep your investment strategy current and aligned with your goals, then you can really tap fully into this very effective retirement tool.