I’ll bet most of the people reading this column right now have an IRA. IRAs are some of the most common types of accounts Americans invest in for their retirement. They are so common that you would think that everyone would know all about them and how they work. Yet a day won’t go by during this upcoming tax season where we won’t get asked the most basic of IRA questions. The following are seven very common misconceptions about IRAs:
1. You “invest” in an IRA. No, you don’t. You “invest” in some type of instrument like a CD, stock, bond, mutual fund, etc. inside of an IRA. An IRA is simply a tax selection on that investment. One way to look at it would be to think of your IRA as just a grocery bag (you know, paper or plastic). The bag only protects the contents or in this analogy, your investment choices.
2. You need multiple IRAs. If your custodian (the institution that holds your account) allows it, one IRA can hold it all. There may be some good reasons for having multiple IRAs, but as far as the IRS is concerned, you can, in most cases, combine a number of IRAs into just one.
3. Beneficiary forms are not that important. Nothing could be further from the truth. Your IRA beneficiary form trumps all other forms. It doesn’t matter what your will or trust says about your IRA money, it will go to the beneficiary named in the IRA documents. One of the biggest mistakes I see in this area is when people don’t have the per stirpes language added onto beneficiary forms. It would take too long to explain in this column, but if you want to protect from possibly disinheriting some grandchildren, then you need to understand this term and how to use it in your beneficiary forms.
4. You can borrow from your IRA. 401k plans often allow you to borrow up to certain limits, but not IRAs.
Most of the time it’s a good idea to roll a 401k plan to an IRA for many different reasons that I won’t go into right now, but most doesn’t mean always. You probably need to work with a really good financial planner to get the correct guidance in this area.
5. You can withdraw money without a 10 percent penalty for hardship. Again, no such animal with IRAs, only with 401k plan.
6. You must withdraw cash. Actually, you can do an “in-kind” transfer for your distribution. Let’s say you own 100 shares of ABC stock. You could withdraw 15 shares (or any amount of shares) as a distribution. That way, you don’t have to sell the shares and rebuy them in your regular account. You simply transfer those shares directly from your IRA to your personal account.
7. You can only convert to a Roth IRA if your income falls below certain limits. Roth conversions are available at any income limit, and those with million dollar incomes are some of the most active at converting their IRAs to Roth IRAs.
Those are seven of the most popular things I see in my office. If you can think of one that I missed, send me an email at email@example.com or firstname.lastname@example.org.