8 IRA Mistakes to Avoid
Owning an IRA is a great step, but getting the most out of these retirement saving solutions requires building your knowledge of just how to use them.
"There's no question that saving through an IRA is a strategic move, but it's not quite as simple as 'set it and forget it,'" says J.J. Montanaro, a CERTIFIED FINANCIAL PLANNERTM practitioner with USAA. "Staying aware of what to do and what not to do can really pay off too." Montanaro shared eight of the most common mistakes IRA investors make, preventing them from taking better advantage of this retirement-saving tool.
1. Thinking you've missed the contribution deadline.
You have until your tax filing deadline -- usually April 15 -- to make an IRA contribution for the previous year. You can even claim a traditional IRA deduction and file your return before you actually make the contribution -- just be sure to follow through.
2. Not contributing enough.
Contributions to a traditional IRA are tax deductible, within limits, so you can help secure your future and cut your tax bill at the same time. If you're younger than 50 years old, you can contribute up to $5,000 in 2012 and $5,500 in 2013. Maxing it out makes for maximum potential tax savings.
3. Not playing catch-up.
Age does have its rewards. If you're 50 or older, you may be eligible to contribute an extra $1,000 (for a total of $6,000 in 2012 and $6,500 in 2013) to an IRA. This catch-up contribution offers a chance to kick your savings into overdrive.
4. Assuming you can't contribute.
If you're a stay-at-home spouse, you can still open an IRA as long as contributions from both spouses don't exceed your combined taxable compensation. A spousal IRA is especially handy when the working spouse is already covered by an employer retirement plan and can't deduct IRA contributions. What you can deduct will depend on your modified adjusted gross income, but every bit counts.
5. Rolling the wrong way.
If you've recently switched jobs or left a job, you can roll the funds from your old employer's retirement plan into an IRA. Just be sure the transfer is made directly from one custodian to the next -- a direct rollover. If the payout goes to you first, it will be subject to a mandatory 20% withholding tax. Then, you'll have only 60 days to move the funds you received, plus the 20% that was withheld, to a new account. If you miss the deadline, you'll have to pay income taxes on the distribution, plus an early withdrawal penalty if you're not at least age 59½. USAA advisers can help you through the rollover process.
6. Not considering a Roth.
You might be able to save more on taxes in the long run by contributing to a Roth IRA instead of a traditional IRA, depending upon your tax situation. Roth IRA contributions aren't tax deductible, but the Roth can provide tax-free withdrawals come retirement time, and the IRS does not require the owner to take annual required minimum distributions. There's another way to put money in a Roth: Thanks to an IRS rule change, anyone, regardless of income levels, can convert money from a traditional IRA to a Roth IRA. Since conversions are subject to ordinary income taxes, you should consult a tax advisor regarding your particular situation.
7. Withdrawing too early.
Your IRA is designed to remain untouched until you reach age 59½. If you make a withdrawal from your traditional IRA before then, you'll have to pay taxes on the income and investment earnings and fork over a 10% penalty, with some qualified exceptions. While a Roth IRA allows you to withdraw your contributions, not including earnings, at any time without taxes or penalties (though with conversions, you may need to wait five years), you'll thank yourself later for not raiding the piggy bank.
More than any technicality, it's plain old procrastination that hurts investors the most. Whether it's uncertainty in the markets, cash-flow concerns or the rising cost of college, there will always be excuses to put off this year's IRA contribution. But time-honored investing principles show that consistent contributions -- through good times and bad -- provide the clearest path to long-term investing success. So make the commitment and take action to help secure your financial future now.