More IRA Mistakes Clients Make

What You Need to Know

A recent Morningstar analysis explores some 20 costly IRA errors that clients can make.
Some missteps are relatively banal and potentially fixable; others are more serious.
One missed opportunity is not contributing to both pre- and post-tax accounts within an employer’s 401(k).

An analysis published a few weeks ago by Morningstar’s Christine Benz contained detailed explanations of 20 potentially costly mistakes that clients can make with their individual retirement accounts. That doesn’t mean it offered an exhaustive list of IRA errors or potential issues to consider.

Benz, Morningstar’s director of personal finance and retirement planning, warns in her report that IRAs are subject to a “Byzantine” set of detailed tax rules that affect withdrawals, required minimum distributions, Roth conversions and rollovers.

Comments shared earlier this week with ThinkAdvisor by a number of CFPs and wealth planners confirmed Benz’s insights. Prospects come in the door after having made any number of errors, ranging from delaying IRA contributions because of short-term market considerations to failing to reinvest unneeded RMDs or not paying enough attention to beneficiary designations.

A number of additional advisors later wrote to expand upon Benz’s list of IRA mistakes, including Crystal McKeon, a CFP with TSA Wealth Management in Houston, and Jaime Quiñones, a CFP and wealth management advisor at Stockade Wealth Management in Marlboro, New Jersey.

Remember the Roth 401(k)

Reflecting on Benz’s third mistake — thinking of IRA contributions as an either/or decision— McKeon said another mistake is failing to account for the potential to contribute to both pre- and post-tax accounts within an employer’s 401(k). Despite their increasing prevalence, many savers fail to realize that Roth 401(k) accounts are even a thing.

“If your employer has the option to contribute to a Roth 401(k), then I think that is a good strategy — to put your employee contribution into the Roth,” McKeon wrote. “Then the employer match is usually contributed to a pre-tax account. This allows you to balance your investments in both pre- and post-tax accounts relatively easily.”

If clients want to change the percentages between the pre- and post-tax contributions, they can split the employee contribution between the two strategies until finding the right allocation.

Failing to Send QCDs Directly From an IRA

Speaking to Benz’s 18th mistake to avoid — overlooking the tax mitigation opportunity presented by making qualified charitable distributions from an IRA — McKeon said the best practice is to avoid having the check flow through the client’s hands.

“In addition to using RMDs to rebalance their portfolio, we also encourage our charitable clients to send their donations to the charities from their IRA accounts,” McKeon explained. “Our custodian will write the check directly to the charity, and the client never needs to take possession of it. This allows our clients to still support charities important to them, but they also do not have to accrue additional unwanted taxes from their RMDs. These charitable donations do not count towards their income.”

Inherited IRAs Cause Confusion

McKeon said Benz’s 20th mistake is spot on.

“Inherited IRAs are an area of confusion, especially with the recent inherited IRA law changes,” McKeon warned.

In her experience, custodians aren’t always ready or able to calculate the RMD for the account holder of an inherited IRA like they will for a traditional IRA.

“It is helpful to have someone willing to walk you through the rules and where your inherited IRA falls,” she said.

Another Big Mistake

Quiñones wrote in to posit that, although not mentioned in Benz’s article, a common mistake he’s encountered is clients not realizing income phase-out limits for both traditional and Roth IRAs — and correcting these issues after the fact.

“I find this often happens with Roth IRAs, because there’s no upfront deduction,” Quiñones explained. “Sometimes, clients won’t even mention to their tax preparer that they have been making a Roth IRA contribution throughout the year. Yet, because of a raise or a bonus, they are beyond the phase-out limit to contribute directly to a Roth IRA based on their filing status.”

If caught early enough, this issue can be corrected through a process known as “recharacterization.”

“However, it becomes more challenging if it has been happening for several years and you must correct several years’ worth of excess contributions,” Quiñones warned. “This can involve the recharacterization of the original Roth IRA contribution and any net income attributable (NIA) associated with that contribution. Unfortunately, I’ve had a few prospects come to me with this situation, and the whole process makes for a complicated situation, with many tax forms generated as a result.”