Last week we discussed several of some common mistakes that IRA holders make — mistakes that you should definitely avoid. When it comes to preparing for retirement, you want to ensure that you are doing everything in your power to not only understand the rules of retirement plans but make those plans work for you, because the last thing you want to do is use some of that money paying unnecessary fees. Below, we will discuss just a few more things that you will want to be aware of when moving forward with an IRA retirement account. We always encourage individuals to do their own research, as there is a wealth of information available for you to view.
Paying Unnecessary Penalties on Early Distributions
The IRS 10% penalty tax on early distributions can be avoided using several methods. Forbes outlines one of them — making a series of substantially equal payments. This distribution method leverages your distributions, which are made as part of a series of substantially equal periodic payments over your life expectancy or the life expectancies of you and your designated beneficiary. It is referred to as Section 72(t) and it will allow you to avoid penalties on IRA distributions even if you are younger than 59 ½.
The IRS allows you to set up this plan using one of three methods:
- The Required Minimum Distribution method – This method uses the IRA owner’s life expectancy and makes distributions of the account balance over that time frame. The annual payment is redetermined each year since both the account balance and the owner’s life expectancy will be slightly less.
- Fixed Amortization method – This method involves the IRA account balance over a specified number of years equal to life expectancy, and at an interest rate of no more than 120% of the federal mid-term rate.
- Fixed Annuitization method – This method involves applying an annuity factor to the IRA account balance to produce a monthly payment. The annuity factor is calculated based on an IRS mortality table and an interest rate of no more than 120% of the federal mid-term rate.
Each of these three methods will produce a slightly different payment distribution, though each ultimately accomplishes the same goal, which is to spread the distribution payments over the IRA owner’s lifetime. Once established, the penalty tax on early distribution will be waived.
Not Taking Advantage of a Roth IRA
A Roth IRA is a potentially valuable retirement resource. Not only are qualified withdrawals tax-free, but Roth IRA distributions do not impact the taxability of Social Security, and Roth accounts pass to beneficiaries tax-free as long as the account is at least five years old. Roth IRAs are the only qualified savings plan that do not require you to take required minimum distributions beginning at age 70 ½ meaning that you can continue to allow your Roth IRA to grow until you are ready to begin taking money out of it. There are income limits that affect eligibility for a Roth IRA, so if you are interested in going this route, we recommend speaking with your investment professional or financial planner.
Not Seeking Advice on an Inherited IRA
Inheriting an IRA can be a great thing, depending on the circumstances — but it is not as simple as it sounds. If you inherit an IRA, you’ll have to be prepared to move quickly. The inheritor will have a few different options for what they can do with the assets depending on their relationship to the deceased, and can inadvertently trigger a big tax bill by tapping the IRA assets without exploring all of the options. If you inherit IRA assets, we highly recommend getting advice from a financial or tax advisor before taking action.
When you inherit an IRA, you will need to plan for taxes. Generally, a non-spouse-designated beneficiary has 10 years to liquidate an inherited IRA. Timing the distributions to match low tax years, or keeping distributions low enough to avoid higher tax brackets can potentially lower the total tax liability. Some beneficiaries, including your spouse, your minor children, disabled persons, chronically ill beneficiaries, and beneficiaries who are not more than 10 years younger than you can take life expectancy payouts.
Furthermore, if you do inherit an IRA, you will want to be crystal clear of the important deadlines included. Estate taxes, if applicable, are due nine months after the IRA owner’s death. This same deadline applies to beneficiaries who wish to disclaim IRA assets. By September 30 of the year following the year of the owner’s death, the beneficiary whose life expectancy will control the payout period must be identified. IRA beneficiaries who want to receive distributions over a life expectancy must begin taking required distributions by December 31 of the same year.
Not Using a Direct Transfer
There are two ways to move funds between IRAs: indirect rollover and direct transfer. In an indirect rollover, you withdraw funds from one IRA and deposit the same amount into another IRA. This must be completed within 60 days and can be done only once a year. Also, a non-spouse beneficiary cannot have an indirect rollover. The failure to follow these rules could result in a taxable distribution. In a direct transfer, a financial institution issues payment directly to another financial institution, which is not subject to the 60-day/once-a-year rules regarding indirect rollover.
We hope you found this information very useful as you move forward with your retirement planning. Of course, when you do open an IRA account, you should always ask any questions you may have and seek out resources that break down every single detail that you need to know about owning an IRA account. Once you can confidently navigate holding an IRA, then contact our non-recourse loan lenders to learn more about how you can leverage your IRA assets with a non-recourse loan to invest in real estate. Give us a call today, we would love to work with you!