One of the most important goals of investing should be maintaining
financial independence in retirement. With that in mind, here are some key
retirement planning tax traps to avoid.
Neglecting taxable savings. Because earnings in
qualified retirement plans and IRAs grow tax-deferred, it seems obvious that
these plans should receive the maximum contribution allowable and perhaps even
the bulk of someone’s available savings. The reality is that the tax hit when
withdrawing these funds in retirement often turns out to be potentially higher
than many thought. Therefore, you shouldn’t overlook systematically saving
after-tax dollars in taxable accounts.
assets in the wrong accounts. Sometimes
investments are held across multiple IRAs, qualified retirement plans, and
taxable accounts. In these situations, it is prudent to strike a balance
between taxable and tax-deferred accounts. It makes sense to talk to a
professional when deciding what to invest and in which account type.
Missing “catch up” contributions. Employees who participate in qualified retirement plans at
work and are age 50 or older can contribute an additional $5,500 in 2013 (or an
extra $1000 in an IRA).
income from the wrong accounts. Understanding
your tax situation is important in determining from where and when to withdraw
income in retirement. Although this decision requires deliberation, you should
consider striking a balance between taxable and tax-deferred accounts to the
extent that income generated from the tax-deferred accounts doesn’t place you
into a higher tax bracket.
capital gains and dividends when current income is needed. If income is needed in retirement from either
tax-deferred or taxable accounts, consider not reinvesting capital gains and
dividends within mutual funds. Rather, let them sweep into a money market fund
for income payout purposes. This may reduce trading costs, turnover, and
potential taxes within taxable accounts. And if the assets are to be withdrawn
within a relatively short time, reinvesting can expose the investments to potential
or no beneficiary designations. It’s important
to avoid a taxable distribution of IRA or qualified retirement plan assets to
the owner’s estate by ensuring there are individual beneficiaries listed on the
accounts (if that’s your intention). Having a trust serve as an unintended beneficiary
of your IRA or qualified retirement plan can create a taxable event at your
death and effectively negate years of tax deferral benefits for the
In most cases it may make
more sense to name individuals as beneficiaries. If the beneficiary of an IRA
or qualified retirement plan is the surviving spouse and that spouse properly
rolls over the distribution into an IRA, the distribution will not be taxed
until the surviving spouse starts distributions. The surviving spouse is not
required to begin distributions until reaching age 70 and a half, unless the
decedent IRA owner had already started Required Minimum Distributions (RMDs).
financial strategies, it’s strongly recommended that you seek outside
professional and/or tax advice.
Chip Gordy, MBA, CRPC is a Financial Advisor with Coastal Wealth
Management, LLC, 10441 Racetrack Rd, Unit 1, Berlin, Md., 21811 and specializes
in Wealth and Retirement Income Planning. He can be reached at 410-208-4545 or firstname.lastname@example.org.