7 Common Mistakes to Avoid When Setting Up an IRA

Individual Retirement Accounts (IRAs) are essential for building a secure financial future. They offer valuable tax advantages and a flexible framework for retirement savings, making them a cornerstone of effective retirement planning. 

Whether you choose a Traditional IRA or a Roth IRA, these accounts can help you grow your savings over time, benefiting from tax-deferred growth or tax-free withdrawals in retirement. 

However, setting up an IRA can be complex, and mistakes can lead to penalties, taxes, and missed growth opportunities. 

According to experts from IRA retirement consulting, this guide highlights seven common mistakes to avoid. By being aware of these pitfalls and taking proactive measures, you can maximize the benefits of your IRA, protect your savings, and ensure a smoother path to a secure retirement. 

Let’s delve into these common mistakes and explore how to avoid them to maximise your IRA investment.

1. Not Understanding the Difference Between IRA Types

Mistake: Many individuals set up an IRA without fully understanding the differences between Traditional and Roth IRAs.

Solution

Traditional IRA: Contributions are typically tax-deductible, which can lower your taxable income for the year you contribute. However, withdrawals during retirement are taxed as ordinary income. This type of IRA may be ideal for individuals who expect to be in a lower tax bracket upon retirement.

Roth IRA: Contributions are made with after-tax dollars, meaning you don’t get a tax deduction in the year you contribute. However, withdrawals during retirement are tax-free, provided certain conditions are met. This makes Roth IRAs suitable for those anticipating a higher tax bracket in the future.

Action Steps

– Assess your current and expected future tax situation.

– Consult a financial advisor to determine which IRA type best aligns with your retirement goals.

2. Exceeding Contribution Limits

Mistake: Contributing more than the allowable limit can result in penalties from the IRS.

Solution

Stay informed about the current contribution limits. As of 2024, the annual limit is $6,500, with an additional $1,000 catch-up contribution allowed for those aged 50 and over.

Action Steps

– Track your contributions throughout the year to ensure you do not exceed these limits.

– Set up automatic contributions that stay within the annual limits.

– Regularly review IRS updates for any changes to contribution limits.

3. Neglecting to Designate Beneficiaries

Mistake: Failing to designate beneficiaries or not updating them as circumstances change can lead to complications for your heirs.

Solution

Designate beneficiaries when investing in an IRA account, and review these designations regularly.

Action Steps

– Immediately designate primary and contingent beneficiaries when opening an IRA.

– Review and update beneficiary designations annually or after major life events such as marriage, divorce, or childbirth.

– Ensure beneficiary information is accurately recorded with your IRA custodian.

4. Choosing High-Fee Investments

Mistake: Investing in funds or accounts with high fees can significantly erode your returns.

Solution

Compare the fees associated with different investment options and opt for low-cost investments where possible.

Action Steps

– Examine the fee structures of potential investments, including management fees, expense ratios, and transaction fees.

– Consider low-cost index or exchange-traded funds (ETFs) offering broad market exposure with minimal fees.

– Regularly review your investment portfolio to ensure it remains cost-effective.

5. Ignoring Required Minimum Distributions (RMDs)

Mistake: Failing to take Required Minimum Distributions (RMDs) from a Traditional IRA can result in substantial penalties.

Solution

Understand the rules surrounding RMDs. For Traditional IRAs, RMDs must begin at age 73.

Action Steps

– Calculate your RMD each year based on the IRS’s life expectancy tables and the balance of your IRA.

– Set reminders to withdraw the required amount annually to avoid a 50% penalty on the amount that should have been withdrawn.

– Consult with a financial advisor to develop a withdrawal strategy that aligns with your financial needs and minimizes tax impact.

6. Overlooking Spousal IRA Contributions

Mistake: Not realizing that a non-working spouse can contribute to an IRA.

Solution

If you are married and file jointly, your non-working spouse can contribute to a spousal IRA, doubling your household’s retirement savings potential.

Action Steps

– Ensure you and your spouse take full advantage of IRA contribution limits.

– Set up a spousal IRA if one spouse has little or no income.

– Consult with a financial advisor to coordinate contributions and maximize benefits for both accounts.

7. Withdrawing Funds Early

Mistake: Taking early withdrawals from your IRA can trigger penalties and taxes.

Solution

Avoid withdrawing funds from your IRA before age 59½ unless absolutely necessary.

Action Steps

– Build an emergency fund outside your IRA to cover unexpected expenses and reduce the temptation to withdraw from your retirement savings.

– Familiarize yourself with exceptions to the early withdrawal penalty, such as using funds for qualified education expenses, first-time home purchases, or substantial medical bills.

– Explore other financial resources or loans to cover emergency expenses before tapping into your IRA.

Conclusion

Setting up an IRA is a significant step toward securing your financial future. 

By avoiding these common mistakes, you can maximize the benefits of your IRA and ensure a more comfortable and secure retirement. 

Stay informed, plan ahead, and seek professional advice to maximise your retirement savings.