Mistake #9 – Too Many Retirement Accounts
(Best used by having your clients or prospects read)
- 9th of 10 from the Book “Top 10 IRA Mistakes and How to avoid IRS Tax Traps”
- Stay tuned for “Mistake 10”
People saving for their retirement years commonly find themselves with more accounts than they know what to do with. How does this happen? Throughout our working years, we have sporadic opportunities to save for retirement and we are told diversification is the key to retirement success. As a result many savers find themselves with multiple retirement accounts; for example, three CDs, a Money Market Account, two annuities, an IRA, a 401(k) or 403(b), and two brokerage accounts. That would be a total of 10 separate retirement accounts and for some, this can be retirement mess.
Having too many retirement accounts is a high-quality problem, but a problem nonetheless. When it is time to convert some of your savings into an income stream, several important considerations must be taken into account.
Here are just a few challenges caused by having too many retirement accounts:
Determine which account you should spend first and how you should withdraw the money
When the time comes to use some of your savings to supplement your retirement income, the more retirement accounts you own, the more difficult it will be to make good choices. One of the biggest and most common retirement mistakes is withdrawing the interest only from your non-qualified CDs, annuities, Money Market accounts, and other interest bearing accounts. Taking the interest only may seem like a good idea, because you will still have your entire principal.
The problem is that all of the interest you withdraw will be considered taxable income. With CDs and Money Market accounts, the interest is currently taxable whether or not you take it out. Your non-qualified savings accounts can be consolidated into one tax-deferred account that will only be taxed when you choose to withdraw some of your interest earnings. These types of accounts, with few exceptions, use the “Last in First out Rule”.
This means when you choose to take withdrawals, they will be considered taxable interest until the entire amount of your interest earnings has been removed. The advantage of tax deferral is you can decide when the tax is due by making withdrawals when it best fits your plans.
Controlling your taxable income after retirement has additional tax benefits. The more taxable income you have, the more likely you will find yourself in a higher tax bracket. If your taxable income exceeds the Social Security income limit, you may be forced to pay income tax on more of your Social Security benefits. Choosing the right account will be less of a challenge if you consolidate some accounts and use income strategies that will lower your overall tax bill.
Determining how to calculate Required Minimum Distributions from multiple qualified accounts
This can be tricky if you own more than one type of retirement account. For example, you may own an IRA, a 401(k), and a 403(b) plan. That would be three different types of qualified retirement plans. In Mistake #1 we discussed the importance of taking Required Minimum Distributions after turning age 70½. Let’s assume that each of your three plans has a balance of $100,000. That comes to a combined total of $300,000. To keep the math simple, let’s assume your RMD for the current year is 5%. You will need to take a total distribution of $15,000 ($5,000 per account) for the current year ’s RMD. You must take the required amount from each of the three accounts. In other words, you cannot take $15,000 from just one account to satisfy the RMD for all three accounts, even though the total distribution would be the same either way.
If all three accounts were IRAs, you would then have the option to choose the account from which you take your RMD. You could choose to take the entire $15,000 from one of the accounts allowing the others to continue to grow tax-deferred. You can also choose to roll the 401(k) and 403(b) into your IRA and then you would only need to manage one qualified retirement account. If you are retired and still have some of your money in a 401(k) or other company sponsored plan, it’s time to roll the plan to an IRA. This will give you greater flexibility and simplify your choices when it’s time to take your Required Minimum Distributions. The more retirement plans you own, the greater your chance of making big retirement mistakes.
Determining whether you will have enough money for a comfortable retirement
This is a big concern for those who are not fortunate enough to have retirement income from a company-sponsored retirement plan. Consider the retired worker who has a Defined Benefit Pension Plan and will receive more than $100,000 a year for life. Unfortunately, the days of the big company pension plans are all but gone. As these types of plans continue to disappear, each year more retiring Americans will need to depend on their IRAs, 401(k)s and other plans to supplement their Social Security. Having these accounts spread all over the place just compounds the problem. Before determining the amount of income you can take from your savings, you need to know how much you have in these accounts. Some accounts may be growing, while others are shrinking. These fluctuating account balances need to be taken into consideration when making income decisions. If you take too much income to fast, you run the risk of running out of income during your retirement years. When the account is empty, the income from that account will stop. Consolidating your accounts can simplify this process and make income decisions less of a task.
Determining whether your beneficiaries are up-to-date in all of your retirement accounts
In Mistake #3 we discussed the many tax traps that IRA owners must navigate when properly setting up beneficiaries. If you have only one IRA, it is difficult enough to get everything set up properly to avoid costly mistakes that can result in accelerated taxes and beneficiaries losing the advantages of the “Stretch Option”. Even worse, your retirement savings could end up in the hands of an ex-spouse or ex-son/daughter–in-law if your beneficiary forms are not kept up-to-date. If you have 10 retirement accounts, the chance of making costly beneficiary mistakes is multiplied tenfold!
Determining what to do with old life insurance policies
Consolidation also can be beneficial in the area of life insurance. Statistics show that Americans commonly own three or more life insurance policies. Most people nearing retirement bought life insurance when they were young and still raising their families. The purpose of life insurance, at that time, was to provide income for the family if they died prematurely. If you are reading this and your children are grown and on their own, that reason is gone.
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