Avoid these 7 common mistakes in your IRA

There are many types of individual retirement accounts (IRAs), but what they all have in common is that they offer you tax advantages to help you set money aside for retirement. And they’re popular—nearly 65 million taxpayers own IRAs.¹ The most commonly used IRAs are:

• Traditional IRAs—The money you put in may be tax deductible
• Roth IRAs—you may be allowed to make contributions and take your money out tax free if you satisfy certain conditions²

Before you open any type of IRA, make sure you understand how they work, the tax benefits, and how they can fit into your overall retirement saving strategy.

1 Know the IRA contribution limits

The IRS limits³ how much you can contribute annually to a traditional IRA or, if eligible, to a Roth IRA. If you want to max out your contributions, make sure you don’t go above the IRS limits. Otherwise, you could owe a penalty. 

2 Check the rules for contributing to Roth 

Not everyone’s eligible to contribute to a Roth IRA. Eligibility is based on your modified adjusted gross income (MAGI) and tax filing status in a given year. There’s no age limit for opening a Roth IRA, and you can keep funding this account long after you retire since required minimum distributions (RMDs) aren't applicable to Roth IRAs during your lifetime. You can review the MAGI thresholds on the IRS⁴ website to learn if you qualify. 

3 Identify IRA tax benefits

When you take your money out of a traditional IRA, you’ll owe taxes on your contributions and earnings. If eligible to establish a Roth IRA, think about your tax bracket now and what you think it may be in retirement. Does it make more sense to pay taxes now on contributions made to a Roth IRA or pay taxes when you withdraw your money in retirement from a traditional IRA?

4 Understand IRA withdrawal penalties

Withdrawals from a traditional IRA or Roth IRA before reaching age 59½ are subject to a 10% penalty tax, unless an exception⁵ applies. Withdrawing from your traditional or Roth IRA early should only be done as a last resort. One way you can try to avoid taking early IRA withdrawals is to consider building an emergency savings fund to pay for unexpected expenses.

5 Understand the Roth qualified withdrawal rule

Before you plan to withdraw from your Roth IRA, you need to know about the Roth qualified withdrawal rule.⁶ Under the rule, you can’t withdraw your earnings tax free until at least five years after your first Roth IRA contribution provided you've attained age 59½ (or withdrawal is made due to disability or death). The five-year period—also known as the five-year clock—starts with January 1 of the year your first contribution was made to any Roth IRA. It’s important for you to understand this rule well in advance of needing the money so it doesn’t interfere with your plans on withdrawing your money, or you could end up with an unexpected tax bill, including a penalty tax if you aren't age 59½ or older.

6 Follow IRA rollover rules

When you want to transfer your money from a tax-deferred plan—such as a 401(k)—to another tax-deferred account—such as an IRA—there are two ways you can do it.

• With a direct transfer, your current plan provider sends the check directly to the new plan provider. 
• With an indirect rollover, your current plan provider gives you the money to deposit into another tax-deferred account. 

With an indirect rollover, you have 60 days to redeposit the entire amount into an IRA (or another tax-deferred account) to avoid income taxes and penalties. You want to make sure you meet the 60-day deadline and write your check for the full amount. 

7 Know when to take RMDs 

IRAs and other retirement accounts require that you start taking money out at a certain age—these withdrawals are called required minimum distributions. Make sure you understand the rules and age that apply to you for RMDs. With traditional IRAs, you must start taking RMDs when you turn 72 (73 if you reach age 72 after December 31, 2022). 

If you miss an RMD withdrawal, you'll owe up to a 25% penalty on the amount you were required to take out. If you have more than one traditional IRA, you're permitted to aggregate the RMDs required from each traditional IRA and take the money out from one or more of your IRAs at your election. You’re responsible to take your RMD on a timely basis each year. The RMD rules don't apply to Roth IRAs while you're alive.

Saving for retirement with IRAs

Traditional and Roth IRAs may be an effective way for you to save for retirement because they can offer you tax advantages—but they come with rules, and failing to follow the rules can cost you money in taxes and penalties. You can help avoid making a costly mistake by understanding the rules for traditional and Roth IRAs. Consult the IRS website for more information and, if you have additional questions, talk to a tax expert or other financial professional who can help answer them.

1 “Who uses individual retirement accounts?” Tax Policy Center, May 2023. 2 In this document, all tax disclosures regarding Roth 401(k) contributions are limited to the federal income-tax code and, in particular, all references to tax-free treatment of qualified distributions are intended to refer to the treatment of such distributions at the federal level only. 3 Retirement topics - IRA contribution limits | Internal Revenue Service (irs.gov). 4 Amount of Roth IRA contributions that you can make for 2022 | Internal Revenue Service (irs.gov). 5 Retirement topics: Exceptions to tax on early distributions | Internal Revenue Service (irs.gov). 6 Participants should contact their plan consultant or financial or tax advisor for specific details on the 5-year rule and whether any special rule may apply.