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.
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.
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.
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.
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.
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.
Now, we want to hear from you! Would like to share your opinion or make a comment on the Unlock Your Wealth Radio Show? If so, then please leave your comment or questions in the space provided below and share this article with your friends and family on Facebook and Twitter. Your comments or question could be chosen as our featured Money Question Monday and a phone call by financial expert Heather Wagenhals could dial your way to be live on the Unlock Your Wealth Radio Show.
Source: Morning Star