Morningstar Magazine - August/September 2017 - 40

Strategies

20 IRA Mistakes to Avoid
From contributions to conversions
and distributions, don't let clients fall
into these traps.

TAX WISE

Christine Benz

their IRAs, investing fixed installments per month
until they hit the limit.
2 Assuming Roth Contributions Are Always Best

For a vehicle with an annual contribution limit
of just $5,500 ($6,500 for those over 50),
investors sure have a lot riding on IRAs. Assets
across all IRA accounts topped $7.5 trillion in 2014,
making the vehicle the top receptacle for
retirement assets in the United States, according
to data from the Investment Company Institute.
In addition to direct annual contributions,
much of the money in IRAs is there because it has
been rolled over from company retirement
plans of former employers.
Opening an IRA is a pretty straightforward matter:
Pick a brokerage or mutual fund company,
fill out some forms, and fund the account. Yet,
there are plenty of ways investors can stub their
toes along the way. Here are 20 mistakes that
investors can make with IRAs, as well as some tips
on how to avoid them.
1 Waiting Until the 11th Hour to Contribute

Investors have until their tax-filing deadline in April
to make an IRA contribution if they want it
to count for the year prior. Many investors take it
down to the wire, according to a Vanguard
study, squeaking in their contributions right before
the deadline rather than investing when
they're first eligible (Jan. 1 of the year before).
Those last-minute IRA contributions have less time
to compound-even if it's only 15 months at a
time-and that can add up to some serious money
over time. Investors who don't have the full
contribution amount at the start of the year are
better off initiating an auto-investment plan with

Morningstar August/September 2017

Investors have heard so much about the
virtues of Roth IRAs-tax-free compounding and
withdrawals, no mandatory withdrawals in
retirement-that they might assume that funding
a Roth instead of a traditional IRA is always
the right answer. It's not. For investors who can
deduct their traditional IRA contribution
on their taxes and who haven't yet saved much for
retirement, a traditional deductible IRA may,
in fact, be the better answer. That's because their
in-retirement tax rate is apt to be lower than
it is when they make the contribution, so the tax
break is more valuable to them now.
3 Thinking of It as an Either/Or Decision

Deciding whether to contribute to a Roth or traditional IRA depends on one's tax bracket today
versus where it will be in retirement. If that is hard
to predict, it's reasonable to split the difference:
Invest half of the contribution in a traditional IRA
and steer the other half to a Roth.
4 Making a Nondeductible IRA Contribution for the
Long Haul

If investors earn too much to contribute to a Roth
IRA, they also earn too much to make a traditional IRA contribution that's deductible on their
tax return. The only option open to taxpayers
at all income levels is a traditional nondeductible
IRA. While investing in such an account
and leaving it there might make sense in a few
instances, investors subject themselves to two big
drawbacks: required minimum distributions,
or RMDs, and ordinary income tax on withdrawals.

The main virtue of a traditional nondeductible IRA,
in my view, is as a conduit to a Roth IRA via the
"backdoor Roth IRA maneuver." The investor simply
makes a contribution to a nondeductible IRA and
then converts those monies to a Roth shortly
thereafter. (No income limits apply to conversions.)
5 Assuming a Backdoor Roth IRA Will Be Tax-Free

The backdoor Roth IRA should be a tax-free
maneuver in many instances. After all, the investor
has contributed money that has already been
taxed, and if the conversion is executed promptly
(and the money is left in cash until it is),
those assets won't have generated any investment
earnings, either. For investors with substantial
traditional IRA assets that have never been taxed,
however, the maneuver may be taxable.
6 Assuming a Backdoor Roth IRA Is Off-Limits
Due to Substantial Traditional IRA Assets

Investors with substantial traditional IRA assets
that have never been taxed shouldn't
automatically rule out the backdoor IRA idea,
however. If they have the opportunity to roll their
IRA into their employer's 401(k), they can
effectively remove those 401(k) assets from the
calculation used to determine whether their
backdoor IRA is taxable.
7 Not Contributing Later in Life

True, investors can't make traditional IRA
contributions after age 70 1/2. They can, however,
make Roth contributions, assuming they
or their spouse have enough earned income
(from working, not from Social Security or their
portfolios) to cover the amount of their
contribution. Making Roth IRA contributions
later in life can be attractive for investors
who don't expect to need the money in their own
retirements but instead plan to pass it on
to their heirs, who in turn will be able to take
tax-free withdrawals. (Roth IRAs aren't subject
to RMDs.)
8 Not Gifting for IRAs

Speaking of earned income, as long as a kid
in your life has some, making a Roth contribution
on his or her behalf (up to the amount of
the child's income) is a great way to kick-start a
lifetime of investing. Per the IRS' guidelines,
it doesn't matter whether the child puts his or her

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