Avoiding the Pickles of IRA Mistakes

by Sandy Kahan

Avoiding the Pickles of IRA Mistakes

by Sandy Kahan

Every year, millions of Americans make contributions to individual retirement accounts (IRAs). Every year, some make mistakes and get into "big pickles" resulting in stiff penalties and hardship for their families.

We've listed the most common IRA pickles and how to avoid them. Of course, it's always advisable to explore your options with a qualified tax adviser.

Sara's pickle—Sara wanted her funds disbursed to her loved ones, smoothly. However, she unknowingly complicated the distribution by the beneficiary she selected.

Many IRA owners plan to leave the funds to their spouse. Some believe naming a trust as beneficiary means their spouses avoid probate court. However, an IRA already is a nonprobatable asset. Others believe naming their estate will be easier for their spouses, but this could cause unnecessary steps, costly legal expenses, and could prevent their spouses from rolling over the funds to their own IRAs.

Helpful tip: The easiest way for your spouse to claim an IRA inheritance is by naming him or her directly as the beneficiary.

Naming a minor as beneficiary also can create a pickle. Because minors don't have access to the funds, the minor generally can't directly receive payments. Payment must be made to a parent or guardian of the minor. That could involve the courts—causing costly legal expenses and delays.

Frannie's pickle—Frannie didn't begin taking required minimum distri-butions when she turned 701/2, as the IRS requires all traditional IRA owners to do. Now Frannie must pay a 50% tax on the money she should have withdrawn.

Helpful tip: If you fail to take a required distribution, the IRS will penalize you. Remember, if you don't need the income you're required to withdraw, you always can reinvest it in a taxable account where it can continue to grow for your future use.

Gerard's pickle—Gerard contributed to the wrong type of IRA. He thought the Roth IRA would yield the best results. He later realized he needs the tax deduction that a traditional IRA allows him. While the IRS usually imposes stiff penalties for mistakes, here the IRS is lenient. Gerard can transfer the funds back to a traditional IRA without penalties.

Helpful tip: The people at your credit union can help you transfer your IRA to a different type. The rules for transferring a contribution are complex, so consult your tax adviser first.

Michelle's pickle—Michelle made nondeductible contributions to her IRA in 1997, but she didn't file IRS Form 8606. This form tracks her IRA basis—the total amount of her nondeductible contributions. Filing this form ensures that she won't pay taxes at withdrawal on money that's already been taxed. Failing to file IRS Form 8606 subjects Michelle to an IRS penalty and means a smaller nest egg when it's time for her to retire.

Helpful tip: Maintain a file of your IRA records, including copies of IRS Form 8606, your IRA agreement, disclosure statement, and beneficiary designation forms. Then you'll have convenient access to backup records.

Patrick's pickle—Patrick had his retirement funds in high-yield, high-risk investments. When the stock market took a dive, Patrick's nest egg got hit.

Financial advisers agree that you should diversify investments. If you keep your entire nest egg in high-risk, higher-earning investments, you could lose everything in our unpredictable economy. On the other hand, if all your retirement funds are in fixed-rate investments, your retirement funds won't have the potential to grow fast enough to keep up with inflation.

Helpful tip: Your credit union offers insured IRA share certificates, which yield higher dividends than a typical share savings account. These insured accounts can fulfill the safe side of your balanced IRA portfolio.

Wanda's pickle—After changing jobs, Wanda spent her pension plan payout money instead of rolling it into an IRA. Now that it's time to retire, she has a much smaller nest egg.

According to the Employee Benefits Research Institute, Washington, D.C. each year workers neglect to roll over 60% of distributions from qualified retirement plans into other retirement plans or IRAs.

Helpful tip: A pension plan payout as small as $1,000 rolled over into an IRA at age 25 would grow to $10,950 by age 65 at an annual rate of 6%. So while it may be tempting to spend that money, it's best to roll over the funds to an IRA.

Mark's pickle—Mark always thought retirement was far away, so he didn't make IRA contributions every year. Now, Mark's retirement funds are limited.

For middle-class Americans, IRA contributions are one of the last remaining tax breaks. Yet, the costly demands of day-to-day living keep many from making contributions to their IRAs.

Helpful tip: It's never too late or too early to make an IRA contribution. So ask the people at your credit union for information, and give early and often—to yourself.

January 1, 1999