5 Things to Never Do With Your IRA

Savings in your IRA are designed to provide you with a financially secure retirement. Take full advantage of this special savings opportunity. But as assets in the account grow, it’s tempting to use money now rather than wait until retirement. Taking money too early not only depletes retirement savings and results in current tax; it can also trigger penalties. Here are 5 things you should never do.

1. Fail to contribute to your IRA

If you have earned income and are under age 70½, each year you can contribute to your IRA up to a set amount (e.g., $5,500 for 2017, or $6,500 if 50 or older by the end of 2017). If you are eligible to contribute but fail to do so, you miss out on an important savings opportunity. The unused contribution limit does not carry over.

How much will an under-contribution cost you? It depends on your situation, but assume that someone age 30 fails to contribute $1,000 each year and retires at 65 (a total of $36,000 missed contributions). Assuming a 7% annual return, the non-contribution would cost the person nearly $150,000 in lost retirement savings.

2. Borrow from your IRA

If you need quick cash, you may think your IRA is a handy source for borrowing. Think again. If you borrow from your IRA, the account ceases to be an IRA and the value of the account becomes taxable (assuming it’s been funded with deductible contributions). If you’re under age 59½, there’s also a 10% penalty.

If you pledge the account as collateral for a loan, the part of the IRA that is pledged is treated as a taxable distribution.

You can tap into the funds and avoid tax problems if you replace them within 60 days. But if, for any reason, you miss the 60-day deadline, then the adverse tax results described earlier apply.

3. Over-contribute to an IRA

Contributions to an IRA can be made for the current year starting on the first of the year and through the due date of the return for the year. For example, 2017 contributions can be made from January 1, 2017, through April 17, 2018. If you contribute early in the year and it turns out that your income is too high to make a deductible contribution because you are an active participant in a qualified retirement plan, you must take action. If you don’t, you’ll be subject to a 6% excess contribution penalty that continues to apply year after year until you correct your mistake. Options:

• Withdraw the excess. If done timely, you can avoid all penalties.
• Apply the excess to the next year. You’ll owe a penalty only for one year.

4. Fail to take RMDs

Once you attain age 70½, you must begin taking required minimum distributions (RMDs). This is so even if you’re still working. If you don’t take RMDs, you’ll owe a whopping 50% penalty on the amount that should have been distributed.

Watch the RMD deadlines. Usually, you must take a distribution by the end of the year. You can postpone the first RMD until April 1 of the following year (the year following the year you reach age 70½), but you’ll have to take a second RMD by the end of the same year (two RMDs in one year).

You can minimize taxes by making a  qualified charitable distribution (QCD). This means instructing your IRA custodian or trustee to directly transfer to a charity the amount of your RMD. QCDs are capped at $100,000 annually.

 5. Fail to name beneficiaries

The benefits of an IRA don’t end with your death. Growth potential for your heirs continues after death…if you plan accordingly. If you name your spouse as beneficiary, your spouse can roll over the funds to his or her own IRA. This allows your spouse to postpone RMDs until attaining the trigger age. It also allows your spouse to name his or her own beneficiaries. A nonspouse beneficiary cannot roll over the account to his or her IRA, but may generally spread RMDs from the inherited account over his or her life expectancy.

If you don’t have a designated beneficiary (such as where your estate is the beneficiary), and your death is before the trigger age for RMDs, all of the funds in the IRA must be disbursed no later than the end of the fifth year following the year of death. This means no more tax deferral on earnings and immediate tax by that fifth year. If you have no designated beneficiary and you die on or after the trigger date for RMDs, the IRA funds must be paid out over your remaining life expectancy at the time of death.

Conclusion

Treat your IRA as the important savings vehicle it is. Don’t mess up on simply actions that can undermine your retirement savings and your heirs’ inheritance.