How to Avoid a Financial-Planning Oops

Creating a financial plan can be simple, however with all the extra financial-services being offered around you, things can get a little complicated. It is possible however to develop the right financial plan for you and your family while maintaining and sticking to your financial goals. Even though you will hit some bumps along your financial path, but staying on that path will help fulfill your financial “Oops” along the way.
The following six financial “oops”, courtesy of Morning Star, will help steer you on the right financial path:
Oops 1: Missing an RMD
Individuals with assets in Traditional IRAs and 401(k)s must begin taking required minimum distributions by April 1 of the year after the year they reached age 70 1/2. The basic idea is that even as the government allows people to enjoy tax-free compounding on their money while they’re in the accumulation mode, at some point the IRS wants its cut.The penalty for not taking your RMDs on time–once you’ve started them, you need to take them by Dec. 31 of each year–is so steep it’s the stuff of legend: You’ll owe not just the ordinary income tax on the distribution, but a 50% penalty on the amount you should have taken but didn’t. The IRS allows you to appeal the penalty if the missed RMD was the result of an unforced error, such as if you were incapacitated or you simply forgot. But you probably still want to avoid that rigmarole if you can.
The Avoidance Tactic: Savvy investors can be strategic about which accounts they pull their RMDs from, to make sure they comply with the tax guidelines while also taking the distribution that makes the most sense from an investment standpoint. I like the idea of weaving RMDs into the rebalancing process, pulling the distribution from whichever funds or stocks you’d like to reduce anyway.
But if you’re concerned about missing an RMD, especially if you’re an older retiree who’s looking to simplify and automate, you can also set up automatic RMDs with your brokerage firm or mutual fund company. You’ll typically have the opportunity to receive distributions on a monthly, quarterly, or annual basis. If you go this route, make sure to maintain a cushion of liquid investments (cash or a short-term bond fund) so that the provider doesn’t have to pull money from a long-term investment when it’s at a low ebb.

Oops 2: Not Signing Up for Medicare at Age 65
Many retirees have gotten religion about deferring Social Security past their full retirement ages; each year of delayed filing for benefits, up to age 70, results in an 8% bump-up in benefits. (Morningstar contributor Mark Miller has written extensively about the virtues of delaying Social Security, as well as more sophisticated strategies like file and suspend.)

But if that’s your strategy, it’s still important to sign up for Medicare at age 65. If you don’t, your Medicare Part B premiums will be permanently higher–and will increase for each year you delay–than would have been the case if you had signed up when you should have. As Miller outlined in this video, Medicare Part B premiums will be 50% higher for the person who waits until age 70 to sign up for Medicare.

The Avoidance Tactic: To avoid those higher premiums, plan to sign up for Medicare coverage three months prior to your 65th birthday, regardless of when you plan to begin claiming Social Security benefits.

Oops 3: Not Updating Beneficiary Designations
Perhaps you made your brother the beneficiary of your 401(k), and got married two years later. Or maybe your husband was the beneficiary of your IRA, but now he’s your ex. In such instances, what’s on your beneficiary designation forms will stand regardless of whether it reflects your wishes, and the beneficiary designation will likely trump what’s laid out in other parts of your estate plan, such as your will.

The Avoidance Tactic: It’s a good idea to revisit your estate plan from top to bottom every 10 years. But if you have a major life change in the intervening years, such as a marriage or divorce, that should be a catalyst for checking up on every aspect of your estate plan, including beneficiary designations. If you’ve used an estate-planning attorney to help draft documents such as powers of attorney and living wills, ask him to also look over beneficiary designations to make sure those designations sync up with the rest of your plan. Furthermore, check up on your beneficiary designations if your company retirement plan has changed providers; I’ve seen instances where the previous designations didn’t automatically transfer over to the new firm. This article details some of the key mistakes that individuals can make with beneficiary designations.

Oops 4: Running Afoul of the 60-Day Rule
The average American will stay at a job 4.4 years, according to the Bureau of Labor Statistics. For individuals with company retirement plans, all those job changes mean a lot of opportunities to roll over assets from the former employer’s 401(k), 403(b), or 457 into the new employer’s plan or an IRA.

Once you’ve pulled your money from the former employer’s plan, you have 60 days to get it rolled over into another tax-deferred receptacle. If you don’t get the money into the hands of the new provider within that window, and you’re under age 59 1/2, the withdrawal will count as an early distribution, and you’ll owe taxes and a penalty on that money. The same problem can crop up if you’re transferring money in an IRA from one provider to the next and the former provider cuts you a check.

The Avoidance Tactic: The best way to ensure you don’t trigger taxes and early-distribution penalties on an IRA or 401(k) rollover is to have the custodians of those accounts deal directly with one another on the transaction, rather than receiving the check yourself. Most providers–especially the one that’s receiving the new assets in its coffers–will make the process fairly seamless. That way, you won’t risk forgetting to send the check to the new provider.

Oops 5: Triggering a Big Tax Bill on a Backdoor Conversion
We’ve written extensively on the topic of backdoor conversions from Traditional IRAs to Roth IRAs. In a nutshell, the maneuver allows individuals–who otherwise earn too much to begin a Roth account–to get money into a Roth by funding a nondeductible Traditional IRA and converting that account to a Roth shortly thereafter. Assuming the individual has no other IRA assets, the only tax due upon the conversion would be any investment appreciation that occurred between the time the account was opened and when the assets were converted to Roth.

Where individuals can get into trouble, however, is if they already have sizable IRA kitties–monies that have never been taxed. When that’s the case, the conversion of the new small IRA could turn out to be a mostly taxable event, as detailed here.

The Avoidance Tactic: The tax trap for backdoor Roth conversions for individuals with large Traditional IRAs can be circumvented if that individual also has access to a decent 401(k) plan. If the plan allows rollovers from IRAs, an individual can move the Traditional IRA assets into the 401(k) prior to conducting the conversion of the new nondeductible IRA to Roth. Thus, the conversion will be tax-free (or nearly tax-free). If a rollover from the IRA to a 401(k) isn’t an option or the 401(k) isn’t very good, individuals are better off forgoing the backdoor Roth maneuver altogether.

Oops 6: Not Rolling Over a Roth 401(k) to a Roth IRA in Retirement
One of the advantages of Roth IRAs is that you don’t have to take RMDs. Confusingly, however, Roth 401(k)s do require RMDs, so if you leave your money in that wrapper, you’ll have to take distributions. They’ll be tax-free, but you’ll still lose an element of control over your plan.

The Avoidance Tactic: This is an easy one: To avoid RMDs from a Roth 401(k), roll the money over into a Roth IRA, which doesn’t require RMDs, before RMDs commence.

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Source: Morning Star


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