Retirement Planning Mistakes Can Be Costly

Retirement accounts like 401(k)s and IRAs are useful retirement planning tools.  However, like any useful tool, they can be misused.  As a tax controversy firm, we see clients make mistakes with their 401(k) and IRA accounts such as incorrect rollovers and failing to take Required Minimum Distributions.  This blog will discuss ways to avoid retirement planning mistakes with rollovers, required minimum distributions, and other common pitfalls IRA and 401(k) holders encounter. 

The first mistake many people make with regards to retirement plans is simply not utilizing them.  If your employer offers a 401(k) with employer contributions, you are turning away free money.  Contributions to accounts like 401(k) and IRAs can be tax deductible leading to lower taxes in the present year.  Unlike a conventional savings account where you have to pay tax on interest every year, 401(k) and IRAs grow tax-free, and you only pay tax on distribution. 

Another common and avoidable mistake is a botched rollover.  A rollover is when a retirement account holder moves funds from one qualified retirement account to another.  For example, moving money from a bank-based IRA to a brokerage house IRA or from a 401(k) to an IRA.  A rollover generally does not trigger any tax consequences if completed within 30 days, so make sure your rollovers are promptly completed.  There are additional rules such as a one rollover per year limit for IRAs.  (Read about some of those rules here).     And it is always recommended to consult with a trusted financial advisor before making any rollovers.  If a rollover error has been made, there is some potential relief available to Taxpayers, but it is easier and less expensive to get the rollover right the first time.

Yet another common problem we see is liquidating a retirement account before retirement age.  We have seen countless incidents where cash-strapped people liquidate their 401(k) and IRA accounts resulting in a large income tax bill (the amount they liquidate is taxable income) as well as a 10% penalty.  Unforeseen tax obligations may also create instances where the tax balance owed is unpaid causing potential additional late payment penalties and interest.  Before liquidating a 401(k) or IRA, look for alternative avenues such as borrowing against a retirement account or seeking liquidity from less the sale of less costly assets. 

Finally, the last common mistake retirement account holders make is failing to take Required Minimum Distributions or RMDs.  Retirement account holders are generally required to take RMDs when they turn 72.  There is a steep 50% tax on the amount that should have been distributed if a retirement account holder fails to take an RMD. 

IRAs, 401(k)s, and other retirement plans are wonderful savings vehicles that everybody should at the very least explore.  While there are potential tax consequences for misusing retirement plans, the potential benefits far outweigh the risks.  A trusted financial advisor should be able to properly advise you not only on how to minimize risks and maximize your investment gains, but also on how to properly manage events like rollovers. 

At RJS LAW we have helped countless clients who have had tax troubles that resulted from the use of retirement accounts.  If your retirement account is causing a tax problem, or you have any other tax related issues, please call us at 619-595-1655 or contact on the web at RJS LAW, for a free consultation. 

Written by Joseph Cole, Esq, LL.M.