Understanding IRAs

Robert HobermanManaging Partner, Hoberman & Lesser CPAs, LLP

Make sure you avoid these common individual retirement account (IRA) mistakes:

  • Not contributing to an IRA due to the modest contribution amounts. While your IRA contributions may not fund your entire retirement lifestyle, they can still provide significant help toward that goal. Make sure you don’t miss out on the higher IRA contribution limits for the next few years. The maximum limit is $6,000 for 2021 (unchanged from 2020). In addition, individuals age 50 and older can make catch-up contributions of $1,000 for 2021 (unchanged from 2020).
  • Not knowing which types of IRAs you’re eligible for. Everyone can contribute to a traditional nondeductible IRA, but the eligibility requirements for traditional deductible and Roth IRA contributions are different. The basic rules follow:
  • Traditional deductible IRA. If you and your spouse aren’t participants in a company-sponsored pension plan, you can make deductible contributions regardless of your adjusted gross income (AGI). Provided the couple’s AGI does not exceed $198,000, a spouse who isn’t an active participant can make a contribution even if his/her spouse is a participant (up from $196,000 in 2020). Active participants can make deductible contributions as long as their AGI is less than $66,000 for single taxpayers and less than $105,000 for married couples filing jointly (up from $65,000 and $104,000 in 2020).
  • Roth IRA. Contributions can be made by single taxpayers with AGI $125,000 or less, and married couples filing jointly with AGI of $198,000 or less (up from $124,000 and $196,000 respectively for 2020). It doesn’t matter whether you are a participant in a company-sponsored pension plan.
  • Not understanding which IRA is a better alternative for you. Traditional deductible and Roth IRAs have very different income tax and estate planning ramifications. With a traditional deductible IRA, your contributions are deductible on your current year tax return, but withdrawals of contributions and earnings are taxed as ordinary income. With a Roth IRA, your contributions are not deductible on your current year tax return, but qualified distributions are not subject to federal income tax. Both IRAs may be subject to estate taxes, depending on your estate’s size and who inherits the IRA. However, heirs must pay income taxes on distributions from a traditional deductible IRA, while distributions from a Roth IRA are income tax free if taken at least five years after the first contribution. Make sure you understand these differences and which alternative is better for you.
  • Not designating a beneficiary for your IRA. Without a named beneficiary, your heirs won’t have as much flexibility when they inherit your IRA and may be forced to take distributions sooner. Make sure you name primary and contingent beneficiaries. These designations control your IRA’s distribution, not your will or other estate documents. There are several situations where it might be beneficial for a primary beneficiary to disclaim part or all of an IRA. By properly naming contingent beneficiaries, you can then control how the IRA will flow to those heirs.
  • Not considering rolling over 401(k) balances to your IRA. Once you retire or leave your job, you can roll over your 401(k) balance to your IRA. Definitely consider this option if you don’t think you’ll use your entire 401(k) balance during your lifetime.
  • Not understanding transfer rules for IRAs. There are two types of IRA transfers. A direct trustee-to-trustee transfer occurs when you authorize your fund to be transferred from one account to another, without taking receipt of those funds. You can use a trustee-to-trustee transfer as many times as you wish in a given year. A rollover transfer occurs when you take receipt of the IRA funds and have 60 days to deposit the funds in another IRA account. Be careful not to miss the deadline or the transfer will be considered a withdrawal. IRA funds can only be rolled over once a year.
  • Not seeking help with your IRA. An IRA can be a valuable tool in helping you achieve your retirement goals. If you have any questions about any aspect of your IRA, contact your financial adviser.