Personal Finance: Individual Retirement Accounts – avoid common mistakes

Chris Hopkins

Last week we reviewed the essential features and benefits of both traditional and Roth IRAs. This week, let’s look at some errors often made by IRA holders and how to avoid them.

n Fun with beneficiaries. Many assets are distributed at death according to the decedent’s will, and must therefore pass through the probate process. Conversely, traditional and Roth IRA accounts (and certain joint assets if properly titled) bypass probate and move directly into the hands of the intended beneficiaries, provided they are properly specified. That last phrase is key; you must specifically name your intended beneficiaries, otherwise the assets will become part of your regular estate, requiring probate and forfeiting the unique tax benefits attendant to an IRA.

You may name as many primary beneficiaries as you like, in any proportion. You can also designate additional recipients in the event that beneficiaries predecease you (called contingent beneficiaries). It is essential that you review your accounts periodically to verify correct beneficiary information and make any necessary changes as circumstances dictate. One common and possibly consequential oversight is forgetting to remove a former spouse following a divorce.

n Avoiding rollover accidents. Transferring assets from an employer’s plan into your IRA is a significant event that requires attention to detail. In most cases, the custodian of the employer plan can directly roll your funds into your IRA account, avoiding tax withholding and preserving the tax-preferred status of your money. If, however, you receive a check, you must act quickly and carefully to keep your rollover tax-free.

You have 60 days from the date on the check to redeposit the funds into another retirement account. If you miss the window, the full amount will be considered a distribution, subject to taxation at your highest tax rate. You may also be subject to the early withdrawal penalty of 10 percent if you are younger than 59 1/2. This mistake is made surprisingly often, and the IRS is most unforgiving in this regard.