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3 Facts About IRAs Every Retiree Should Know

By Dan Caplinger - Dec 16, 2017 at 6:49AM

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Don't let your retirement account give you a nasty surprise.

IRAs have helped millions of Americans set manage trillions of dollars in retirement savings. Smart taxpayers take full advantage of IRAs during their careers in order to maximize their savings and reap the valuable benefit of tax deferral and either up-front deductions for traditional IRA contributions or tax-free withdrawals from Roth IRAs. Yet in order to make sure you get the most out of your IRA, there are a few facts about these retirement accounts you need to know. By keeping the following three things in mind, you'll better understand the true power of your IRA and what you need to do to make sure it works as hard as it can for you.

1. Some IRAs require you to take withdrawals, but others don't

Congress knew when it enacted the laws that created IRAs that some taxpayers would want to take advantage of their tax advantages for as long as they possibly could. That's why the rules for traditional IRAs included provisions that forced retirement savers to start taking withdrawals from their accounts after they retired. Required minimum distributions from traditional IRAs must begin the year you reach age 70 1/2, and the amount you have to withdraw is calculated based on the value of the IRA and your life expectancy as calculated using IRS tables. Fail to do so, and you'll owe the IRS a whopping 50% penalty on what you should have taken out.

Roth IRAs, however, have no RMD provisions. Lawmakers were less worried about Roth IRAs because they used after-tax money, and withdrawals in retirement generate no tax revenue for the government. Those who prefer to control when they will take money out of their IRAs should look closely at Roths in order to avoid having to deal with required minimum distribution rules.

Interstate road sign design with IRA written on it, under a blue sky with a few clouds.

Image source: Getty Images.

2. You can convert an IRA to a Roth even if you can't contribute to a Roth directly

Not everyone can open a Roth IRA. When they were first created, there were income limits that applied both to contributing to Roths and to converting assets from other types of retirement accounts to Roths. The net impact was to lock out high-income taxpayers from ever getting access to these valuable tax-free retirement accounts.

In 2010, Congress eliminated the income limits for Roth conversions. That opened the door for all taxpayers to have Roth IRAs, but because lawmakers kept the Roth contribution income limits in place, the only choice that high-income taxpayers had was to convert an existing IRA. Converting a Roth has immediate tax consequences, but for many retirees, the up-front tax cost can be worth it in order to reap the benefits going forward.

3. Naming an IRA beneficiary is crucial

One thing that many retirees neglect to do is to choose a beneficiary for their IRAs. Unlike regular investment assets that pass to heirs according to the provisions of your will, an IRA beneficiary designation is necessary in order to make sure that the people you want to inherit your IRA will get the maximum tax benefits possible.

If you fail to name an IRA beneficiary, then the assets will go to your estate. That might sound like exactly what you'd want, but if your executor takes withdrawals from the IRA to fund bequests, then it can generate immediate taxable income for the estate or its heirs. That can take away the right that many heirs would otherwise have to stretch out their distributions over the course of their lives. Meanwhile, some IRA owners name beneficiaries but then fail to change them after major life events like marriage, divorce, or the birth of children or grandchildren. That can lead to bigger problems, especially if you thought that changing your will was good enough to cover all your assets. Take a moment to check your beneficiary designations on your IRAs and make sure they're the people you truly want to get your retirement money after your death.

Be smart about IRAs

IRAs are valuable tools, but you have to use them correctly. If you keep the three things above in mind, you'll be in a better position to enjoy your retirement.

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