2 Bad IRA Pitfalls You Can Avoid

2 Bad IRA Pitfalls You Can Avoid

People now depend on individual retirement accounts for income in later years. Even if you are in an employer’s 401(k), you will roll that into an IRA when you retire. But there are traps along the way.

Rick Kahler, founder of Kahler Financial Group, in Rapid City, S.D., tells what they are and how to avoid them. A second chat on the subject will appear later.

Larry Light: IRA investing seems simple, yet isn’t, right?

Rick Kahler: Investing through an IRA is a fundamental method of retirement saving. Opening and contributing to an individual retirement account is not hard. That doesn’t mean IRAs are simple and easy to understand.

I was reminded of this at the 2018 spring conference of the National Association of Personal Financial Advisors, where I attended a workshop by Jeff Levine of Fully Vested Advice on “10 Critical IRA Mistakes.”

Light: And failing to use some of it for charity is among them?

Kahler: Yes. Top on his list of mistakes was failing to make charitable contributions out of your IRA when you are over 70½. These are called Qualified Charitable Distributions (QCDs). Here is why giving to charity directly from your IRA is a good idea. For traditional IRAs, at age 70½ you must begin to withdraw required minimum distributions (RMDs) whether you want to or not. An RMD is taxable at ordinary income rates. Further, if you make a charitable donation and you are over age 65, you now must have over $13,300 of itemized deductions per person to get any portion of it deductible.

By donating out of your IRA, you can reduce your RMD by an amount equal to your charitable gift. This makes your charitable gift 100% deductible and lowers your adjusted gross income, which can also help lower your Medicare premiums.

Light: Can you give us an example?

Kahler: Assume you are age 71, give $9,000 a year to charity, your property taxes on your home are $2,500, you are in the 22% tax bracket, and your RMD is $10,000. Without planning you will take your $10,000 RMD and pay $2,200 of income tax on it. Since you only have $11,500 in itemized deductions you will take the standard deduction of $13,300.

If instead you contribute $9,000 to charity out of your IRA, you reduce your taxable RMD from $10,000 to $1,000, slashing your tax liability on it from $2,200 to $220. The savings of $1,980 would cover most of your property tax.

If you make a QCD like this, it’s essential to inform your tax preparer. There is no required written evidence from your IRA custodian that your RMD needs to be offset by the amount of your gift. It’s your responsibility to tell your accountant so they report the correct reduced amount of the RMD on your tax return.

Light: And the second big mistake is not doing the right thing if you run into a financial jam?

Kahler: There are complex asset protection rules for IRAs and retirement plans. Protection differs between bankruptcy and non-bankruptcy creditor actions.

In bankruptcy, all employer plans (ERISA), SEP and SIMPLE IRAs, and rollovers from retirement plans to IRAs are 100% protected from creditors. Amounts you personally contributed to traditional and Roth IRAs are protected up to a total of $1,283,025. However, inherited IRAs are not covered. You can see why it’s important to keep traditional, rollover and inherited IRAs in separate IRA accounts.

Light: It gets more complex, I suspect.

Kahler: To make it even more complicated, different rules apply if creditors sue in non-bankruptcy proceedings. ERISA plans are 100% protected in all states. All IRAs are 100% protected in most states, except California, Georgia, Maine, Mississippi, Nebraska, South Dakota and Wyoming, where they have limited to no protection.

Solo 401(k), SEP IRA, and SIMPLE IRA plans are fully protected from non-bankruptcy proceedings in about half of the states. The others, including South Dakota, have limited or no protection. If you live in one of these states and have a Solo 401(k), SEP, or SIMPLE, you want to roll it into an IRA as soon as circumstances allow.

Light: Anything else to watch out for?

Kahler: I’ll cover three more next time. These mistakes can be costly. To avoid them, especially if your circumstances are at all complex, it’s wise to get tax and IRA withdrawal advice from qualified financial advisors.

Source: Forbes
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