Sometimes bad money judgment hurts no one. The pricy suit that was purchased and never worn or the expensive dinners bought for the person you now despise may cause pangs of regret. But your future is basically no worse off in the wake of these questionable choices.
Bad decisions in your IRA account, however, can have lasting effects that can haunt you to your grave.
An IRA is basically a time capsule, sealed up now for future use to fund your life after you leave work. Mistakes that could jeopardize the tax-advantaged status of the money in your account or rash investing decisions that decimate its value threaten your retirement.
Read on to learn how to avoid missteps, misadventures and calamities with your IRA account.
The Bankrate Daily
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Don’t take loans or early withdrawals
When you really need cash and happen to have a pot of retirement money, taking an early withdrawal may be the best option. Of course, few experts will recommend doing this.
“For most instances, IRA accounts should be considered a last option to cover a household expense,” says CFP professional Eric Schaefer, a financial adviser with Evermay Wealth Management in Arlington, Virginia.
Early withdrawals generally trigger a penalty. The IRA account owner will have to pay a 10% early withdrawal fee to the IRS, along with any taxes due. For a traditional IRA, the entire withdrawal will be subject to income tax. With a Roth, your contributions can be withdrawn at any time, tax- and penalty-free, but earnings withdrawn early will be hit with the tax and penalty stick.
Regardless of the cost at the time, cracking open an IRA account early undermines the future growth of the account. “The combination of taxes and the loss of future earnings can be crippling to one’s financial future,” Schaefer says.
Missing the opportunity for compound growth can really cost you. The chart above shows the accounts of 2 people. “John” saves $5,500 every year and earns an 8% annual return on average, while “Mary” does the same thing, but in the 5th year she cashes out $10,000. After 20 years, Mary ends up with $50,000 less than John. That’s not chump change.
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Don’t ignore your beneficiaries
You can ignore your beneficiaries in life. No one is forcing you to call your mother or nieces or siblings. But don’t ignore the beneficiary designation form for your IRA.
“I met with a couple and they looked at their retirement account beneficiaries and found that the beneficiary on the husband’s account was his ex-wife. They had been divorced for 20 years and he had never thought to update the beneficiary forms,” says CFP professional Michael Silver, partner at Baron Silver Stevens Financial Advisors in Boca Raton, Florida.
“I told the wife not to kill him until the form had been updated,” he jokes.
Avoid leaving your life savings to the wrong person and amend your beneficiaries as life evolves.
It can also be extremely worthwhile to check every year or so just to make sure everything is shipshape. Errors perpetrated by the account custodian are not unheard of. If your beneficiary information isn’t on file, well, your beneficiaries are S.O.L. (so out of luck).
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Don’t ruin your beneficiaries’ tax shelter
Even if you have a will, you should always name beneficiaries for your retirement accounts. This is to avoid the probate process and preserve the ability of your heirs to stretch the IRA over their lifetime.
“Naming a beneficiary allows an individual to accept the account as an inherited IRA and stretch the taxes over time and take a little bit of money out each year,” says Silver.
The stretch IRA option keeps the funds inside the tax-protected wrapper of an IRA. The money in the account can grow and compound over time without having a big bite chomped out all at once to pay taxes. Instead, minimum distributions can be taken every year based on the beneficiary’s life expectancy.
If the account’s beneficiaries cannot stretch the account over their lifetime, they have to take withdrawals within 5 years of the owner’s death. With traditional IRAs that can lead to a big tax bill.
Sure, there are worse problems to have, but the beneficiary form is so simple to fill out. Why give the government your money before you have to — even if you’re dead?
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Just say ‘no’ to 60-day rollovers
When it comes time to move your account, do a direct transfer between custodians. Don’t have a check issued to you with the plan to put it back into an IRA within 60 days. That is an option. But it’s a very tricky one.
The rules have changed recently, says Silver.
Before 2015, IRA owners could do an indirect transfer, a 60-day rollover, every 365 days for each IRA they owned. The IRS put the kibosh on that in 2014. Now, if you have 100 IRAs, you can do a 60-day rollover with only 1 of them.
“(Direct transfers) are the safest way. You can do them as many times as you want and you don’t have to worry about staying in the complicated rules,” Silver says.
“And the IRS is not real lenient with this stuff,” he adds.
Don’t expect your bank or brokerage to keep track of transfers. One slip-up with the 60-day rollover and you no longer have an IRA. Instead you’ll have a big penalty and hefty tax bill to pay.
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Don’t let cash languish
Just getting contributions into an IRA in a timely fashion can be a huge mountain to scale. Your reward for conscientious saving is a bunch of homework in the form of investment decisions. But that homework will pay off in the long run.
“Put cash to work,” says Lena Haas, senior vice president of retirement, investing and savings at E-Trade Financial.
“Emotional decision-making can also cause investors to keep too much cash in their investing accounts,” she says.
Investors need a basic plan in place. It doesn’t need to be complicated. Just have a plan to put contributions into investments as soon as possible so they can begin earning a return and compounding.
Compounding happens when your contribution begins earning interest. The interest in the account begins to earn interest and in time the balance increases exponentially.
What difference does it make if you wait 6 months each year to invest the money? It can mean a difference of $10,000 in your IRA account balance after 20 years, according to a Bankrate analysis of one scenario.
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Don’t follow the crowd
This is the correct order of things: buy low, sell high. Don’t be the person who panics and sells every time the market dips.
“It is human nature to do this,” says Peter Jacobstein, senior vice president at Folio Investing.
“We have seen that days with the heaviest redemptions were when the market was down. Stocks went on sale and people would sell and when the market went up they would buy,” he says.
Once you’ve paid money to get out of these investments, you may very well have to pay again to buy them — at a higher price. This type of behavior results in the misguided strategy of selling low and buying high.
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Don’t try to time the market
It’s nearly impossible to correctly time the market. Even if you successfully jump out of the market at a good time, getting back in to catch the rebound can be tricky. If you include the cost of trading, the whole exercise is most likely to be a wash, at best, or an expensive mistake.
Instead of running around in a mortal panic, plan ahead. The market will go down and IRA money won’t be needed until retirement. Keep in mind that over time, the market is resilient and will recover from a swoon — even a big one.
Align your expectations with the many years the money will be invested. Pad your portfolio a little bit with stable investments and bolster your confidence by constructing an investing policy you can live with.
Or hire a financial professional: It is his or her job to get your money invested and help you leave it alone.