2/22/2012 3:38 PM ET|
8 ways to totally mess up your IRA
The rules can be confusing, so it's important to understand what you're allowed to do, and when, to maximize your retirement savings.
Mistake No. 1: Living for today only
IRAs, or individual retirement accounts, may be trickier than you think. And what you don't know can cost you money.
Many of the most common IRA mistakes occur simply because people don't know the rules governing these accounts -- of which there are many. Complex rules provide many opportunities for things to go awry, but the biggest mistake with IRAs may be not contributing to one at all.
"If you don't put anything in, you won't have anything at the end," says IRA expert Ed Slott, the president of Ed Slott and Co., and author of "The Retirement Savings Time Bomb . . . and How to Defuse It."
Each year that you're eligible to make IRA contributions and don't is a chunk of retirement income lost. The most significant factor in the amount of money accumulated at retirement is the amount you save, not the rate of return on investments.
In general, "if you run the numbers, someone who doesn't skip contribution years versus someone who does, the person who doesn't skip years will end up with more money in retirement," says Ken Hevert, vice president of retirement products at Fidelity Investments.
Mistake No. 2: Missing tax-free growth
The Roth and the traditional are the most widely used IRAs.
Both allow annual contributions of $5,000, but they receive different tax treatment. In a nutshell, Roth IRA contributions are made with after-tax money, while contributions to a traditional IRA may qualify for a tax deduction for the year the contribution was made.
With the Roth, taxes are paid on the front end so that in retirement all distributions, including interest and earnings, are tax-free. Conversely, the traditional IRA generally gets a tax advantage at the time the contribution is made, but distributions are taxed as ordinary income in retirement. (Should you convert to a Roth IRA? Check MSN Money's calculator.)
There is an exception to that rule. High earners who are covered by retirement plans at work may not qualify for a tax deduction.
Big moneymakers are hemmed in on the Roth side as well.
Income limits prohibit high earners from contributing directly to a Roth. A married couple who files taxes jointly and earns more than $183,000 per year cannot contribute to a Roth, and single people who earn more than $125,000 are also prohibited.
But all is not lost. Read on to see how to sidestep these apparent obstacles to IRA investing.
Mistake No. 3: Losing opportunities due to ignorance
Make too much money to contribute to an IRA? You can get around this problem.
High earners can still take advantage of the Roth IRA by contributing to a nondeductible IRA and then converting to a Roth. A nondeductible IRA is simply a traditional IRA for which there is no tax deduction, and it is available to almost everyone with wages or self-employment income.
"I do that myself. I make too much to contribute to a Roth, so I can contribute to a nondeductible IRA and convert it to a Roth," says Slott.
"It's really just moving money from a taxable pocket to a tax-free pocket. Why wouldn't everybody do it to shelter their money from future higher taxes at no cost?" he says.
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The most significant factor in the amount of money accumulated at retirement is the amount you save, not the rate of return on investments.
Well that's just straight up mis-leading bullsh**. You can save less and end up with more if your return is higher, as anybody with any knowledge of savings and return knows. Now, given a fixed rate of return, obviously you'll have more if you put away more, but saying rate of return is not significant is like saying the interest rate on a mortgage is not significant - totally stupid.
Having an IRA is good for savers because you save tax free and since compoud interest is the second greatest force in the world after atomic energy. When you have to withdraw RMD required minimum distribution money you then pay taxes onthat money and all that interest for the first time after 30-40 years. Nlobody says you have to spend it by the way!!
best thing you can do for your IRA is "Self Direct " it!!!
put it in some non traditional investments...get a good IRA custodian who wont fee you to death!! Take the fund , and make it work for you!!
Dont just sit on it!!
Great article and thank you for the link early in the article to the ebri site. Incentive... for those able to claim the Form 8880 credit...contribute to an IRA, lower your AGI, get a credit up to 50% of contributions made up to 4,000 on a joint return...example below:
Several years later, after 8880 is no longer a HUGE advantage convert that accumulated IRA as long as effective tax rate is below 28%, you are paid - paid quite well to convert to Roth for future tax free retirement...
Young Al and Brenda have a 6 year old daughter they file a joint return
Al has 15,299 in wages
they got a nice refund last year of 1000 from child credit and EIC
they have 160 in dividends
they also (bear with me here) won a radio prize worth 2,800 and hit the slots for 3,700 this year - unlikely, but this is for effect - helps the EIC...
they decide to put last years refund to work in an IRA and also put 3000 into an IRA too - total 2000 each
AGI ends up being 33939
tax is 1108
Form 8880 credit eats up the tax at 1108, 0 tax
*IRA not only reduced their AGI (reducing their base tax and raised their EIC, but TOTALLY wiped out tax)
This year EIC 1152 refundable
this year child tax credit 1000 refundable
More than half way there for next year's IRAs
rinse and repeat.
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