From contributions to conversions to distributions, don't fall into these traps when managing your IRA.
1. Waiting until the 11th hour
Investors have until their tax-filing deadline — usually April 15 — to make an IRA contribution if they want it to count for the prior year.
Many investors squeak in their contributions right before the deadline rather than investing when they're first eligible (Jan. 1 of the year before). Those last-minute contributions have less time to compound, and that can add up.
2. Assuming Roth IRA is best
Funding a Roth instead of a traditional IRA may not always be the right answer.
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 maybe better. That's because their in-retirement tax rate is apt to be lower than it is when they make the contribution.
3. Thinking of it as either/or
Deciding whether to contribute to a Roth or traditional IRA depends on your tax bracket today versus where it will be in retirement.
If you have no idea and your income allows you to make a deductible IRA contribution, it's reasonable to split the difference and invest half in each.
4. Making it nondeductible
If you earn too much to contribute to a Roth IRA, you also earn too much to make a traditional IRA contribution that's tax-deductible.
The only option open to taxpayers at all income levels is a traditional nondeductible IRA, but this subjects investors to two big drawbacks: required minimum distributions, or RMDs, and ordinary income tax on withdrawals.
5. Presuming it's tax-free
The backdoor Roth IRA should be a tax-free or nearly tax-free maneuver in many instances.
However, for investors with substantial traditional IRA assets that have never been taxed, the maneuver may be partially taxable, thanks to the "pro rata rule."
6. Ruling out backdoor IRA
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
Making Roth IRA contributions later in life can be attractive for investors who plan to pass on the money to their heirs, who in turn will be able to take tax-free withdrawals. After all, Roth IRAs don't impose RMDs. Traditional IRA contributions will tend to be less attractive for older adults because they do.
8. Delaying contributions
Investors might put off making IRA contributions, assuming they'll be tying up their money until retirement. Not necessarily.
Roth IRA contributions can be withdrawn at any time and for any reason without taxes or penalty, and investors may withdraw the investment-earnings component of their IRA money without taxes and/or penalty under specific circumstances.
9. Running afoul of rule
All investors must satisfy the "five-year rule," meaning the assets must be in the Roth for five years before they begin withdrawing them. Things get more complicated if your money is in a Roth because you converted traditional IRA assets.
So, get some tax advice if you need to pull money out of a Roth IRA shortly after depositing it.
10. Doubling up tax shelters
It also makes sense to avoid any investment type that offers tax-sheltering features itself. That's because you're usually paying some toll for those tax-saving features, which you don't need because the money is inside of an IRA.
