We recently encountered a situation involving an investor who had separated from a long-term partner. Her ex had managed her traditional IRA, from choosing investments and monitoring performance to keeping track of statements and ensuring she made contributions. Now that they had parted ways, she wanted to understand her account and learn how to manage it to avoid any unwanted taxes or penalties due to a lack of knowledge.
First and foremost, we advised her to update her beneficiary designation. Given their long relationship and the fact that her ex had been managing the account, it’s likely that he is still listed as the beneficiary. Since IRAs pass outside of a will, whoever is the named beneficiary will receive the account, regardless of any intentions expressed in the will or by the executor of the estate.
Next, we evaluated her IRA in the context of her other investments. Does she contribute to a workplace retirement plan? This could affect the deductibility of her IRA contributions for tax purposes. Additionally, if her contributions were tax deductible, it’s likely that most of her retirement funds are being saved pre-tax, meaning they will be taxed at ordinary income rates when withdrawn in retirement. While this isn’t inherently a problem, it is an important factor to consider in planning. For example, while she might view her account as holding $1 million for investment purposes, the value during distribution is different. She may need to withdraw $1.20 to $1.40, depending on her tax rate, for every $1 she intends to spend to cover the taxes due, which could result in her retirement funds not lasting as long as anticipated.
Another aspect to review is whether she has ever made non-deductible contributions to the IRA because of income limitations. Most custodians do not track the after-tax balance, so she needs to check her tax returns for Form 8606. When she takes distributions, they will include a pro-rata portion of pre-tax and after-tax assets.
Now that she no longer has a financially savvy partner overseeing her decisions, she must understand that her IRA is not a piggy bank. Withdrawals made before she turns 59½ could be subject to a 10% early withdrawal penalty, plus taxes. While there are exceptions to this penalty, once withdrawn from the IRA, funds cannot be returned since investors are limited to contributing $7,000 annually in 2024 and 2025, with an additional $1,000 for those age 50 and older. We believe early withdrawals should be a last resort. In the future, she’ll also need to stay aware of the required minimum distributions (RMDs). Currently, the law mandates withdrawals starting at age 75, but since this is more than 30 years away for her, the rules could change.
In addition to learning how to manage her IRA, it is an opportune time to reassess her overall financial plan, as she now needs to plan for a solo retirement. She may need to adjust her savings rate, consider tax diversification in her accounts, and possibly reassess her investment strategy to ensure it aligns with her goals.
If you have questions on how to manage your IRA, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Listen to the October 5, 2024 “Henssler Money Talks” episode.
This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
