8 Roth IRA Mistakes That Could Be Costing You THOUSANDS

roth ira mistakes

If you’ve been following our YouTube channel, you’ve probably heard me talk about Roth IRAs. And that’s because they’re one of the best possible ways to save for retirement. And, in my opinion, and the opinion of pretty much every financial advisor out there, pretty much everyone should have a Roth IRA. 

These investment accounts allow you to contribute after-tax income up to a certain limit each year and then withdraw that income during retirement tax-free. The idea here is that you’re going to be in a higher tax bracket when you retire than when you contribute the money, which is true for most people. 

And, if you’re a bit lost here, you can watch our video that explains all the basics about Roth IRAs and get up to speed.

But, for the most part, just understand that saving and investing your money through a Roth IRA could end up saving you thousands of dollars in taxes. However, just like any other type of retirement account, a Roth IRA has some rules. And, when you break those rules, the government is going to come down on you hard and eat away at your savings before you can even reap the benefits of them. 

So, when investing through a Roth IRA, it’s super important to avoid a couple of mistakes. And, in this article, I’m going to tell you 8 of the most common and most costly mistakes that people make when investing through Roth IRAs so that you can avoid getting hit with penalties and make the very most out of your Roth IRA account. These are the 8 Roth IRA mistakes you should avoid.

#1: Not Getting a Roth IRA Because You Have a 401(k)

roth ira vs 401k

If you’re lucky enough to have a 401(k) plan provided by your employer, that’s probably going to serve as the backbone of your retirement savings. However, there are some great reasons that you should add a Roth IRA to your savings portfolio in addition to your 401(k).

For one, having a Roth IRA in addition to a 401(k) means that you’ll be able to keep saving even after you hit your 401(k) contribution limit. In 2022, if you’re under the age of 50, the most that you can contribute to a 401(k) per year is $20,500. However, if you have a Roth IRA on top of your 401(k), you’ll be able to save another $6,000 per year for retirement in your Roth IRA account and you can contribute up to $12,000 if you’re a married joint tax filer.

Then, you’ll be reaping the tax benefits of both the 401(k) and the Roth IRA. So, you should definitely contribute to your 401(k) first, especially if your employer will match your contributions. But, if you’re able to save even more over that $20,500 limit, then it’s super useful to have a Roth IRA where you can put that excess money.

#2: Contributing to a Roth IRA if You Have Too Much Income

roth ira accounting

Now, if you’re in a position where you don’t qualify for a Roth IRA, it’s most likely because you’re in a pretty good spot financially. What I mean is that the government puts a cap on the income you’re allowed to have in order to qualify for a Roth IRA. 

For single filers in 2022, those with a modified adjusted gross income of over $144,000 are not allowed to contribute to a Roth IRA and joint filers with a modified adjusted gross income of over $214,000 also do not qualify. This is basically the government’s way of saying, “You don’t need these tax benefits, so we’re not going to give them to you.” 

And, if you do contribute to a Roth IRA when you have over that income limit, they’re going to hit you with a penalty, which is a 6% tax on every dollar that sits in your Roth IRA account each year. So, if you have above either of those income limits, plain and simple, do not contribute money to a Roth IRA. 

You should also know that, if your income is between $129,000 and $144,000 as a single filer and between $204,000 and $214,000, then you’ll only be able to contribute a reduced amount. 

#3: Missing Out on a Backdoor Roth IRA

backdoor roth ira

For those of you watching that were about to click out of this article because you make over $144,000 a year and you thought there was nothing that a Roth IRA could do for you, I have good news. Using a pretty well-known tax loophole, known as a backdoor Roth IRA, you can still reap all the benefits of a Roth regardless of what your income level is. 

This is how it works. First of all, there are no income limits for traditional IRAs. So, you start by contributing your savings money into a traditional IRA. Then, you can immediately convert it to a Roth IRA. Yes, it’s that easy. But, you need to make sure that you convert it immediately. If you wait, then you might have to pay a capital gains tax when you convert it to a Roth.

Also, opening a backdoor Roth might not be the best move for everyone. Since you’re moving the money from a traditional to Roth IRA and paying income tax on it, the amount of money that you have in your IRA becomes taxable income for that year. And that amount of money could potentially bump you into a higher tax bracket and cause you to pay a higher income tax rate. 

So, before you go putting money into a backdoor Roth, you should definitely consult an accountant or financial planner and figure out if it’s the best move for you. But, in many cases, using the backdoor Roth loophole is not something you do not want to miss out on. 

#4: Exceeding Contribution Limits

roth ira contributions

If you’re under the age of 50, regardless of whether you’re putting your money directly into a Roth IRA or doing a traditional IRA and converting it to a Roth, you can’t contribute more than $6,000 per year. And you need to make sure you stay under that limit or else the IRS is going to hit you with a penalty. 

All funds over $6,000 will be hit with a 6% excise tax every year that you leave them in the account until you correct the overage, just like if you contribute to a Roth and you’re over the income limit. And that can cost you a lot of money. 

Just imagine if you accidentally put $10,000 into your Roth instead of $6,000. That’s going to cost you $240 every year until you correct it because 6% of that extra $4,000 is $240. 

So, make sure you don’t exceed that $6,000 or whatever your limit is if your income is between $129,000 and $144,000 and you have a reduced contribution limit. Remember that whole thing from part 2? Then, you won’t have to pay that 6% tax

#5: Not Contributing for Your Spouse

spousal ira rules

You cannot contribute more to a Roth IRA than you earn in a certain year. So, if you or your spouse is a stay-at-home parent and aren’t earning any income, then you aren’t eligible to contribute to a Roth IRA.  But, there’s a workaround and it’s called a spousal IRA

This allows you to set up an IRA account for a spouse that is non-income-earning and have the income-earning spouse contribute up to $6,000 per year to it. So, if you’re the income-earning spouse in a relationship right now and you only have a Roth set up for yourself and not your spouse, you can instantly double your contribution limit by opening up a spousal IRA. 

That way you can contribute $12,000 a year between the two Roth IRAs, get double the tax benefit, and have some serious savings for your family when it’s time to retire. 

#6: Doing Rollovers Incorrectly

401k ira rollover

Moving funds from any retirement account into another type of retirement account is what’s called a rollover. Most commonly, people tend to roll over funds from their 401(k) to a Roth IRA. And this is just another advantage of having both types of accounts. 

So, why do people prefer to have their money in a Roth over a 401(k)? Well, 401(k)s usually have far fewer investment options than Roth IRAs. With a 401(k), you can usually only invest in a few different mutual funds from one single provider. With an IRA, you can choose to invest your money with pretty much any type of security: individual stocks, mutual funds, and ETFs. Many IRAs will even allow you to hold crypto. 

So, if you want to rollover funds from a 401(k) to a Roth IRA, you need to know how to do so correctly or you could end up paying a penalty. First of all, the biggest rollover rule to be aware of is the fact that the IRS only allows you to do one rollover every 365-day period, even if they occur in different calendar years. That means that you can’t do a rollover in November 2022 and then do another one in February 2023. You have to wait until November 2023 to do another rollover. If you do two rollovers in a year without realizing it, it could result in a huge tax bill. 

Another rule you need to adhere to is the 60-day rule, which states that you must complete the rollover deposit within 60 days of initiating the rollover. If you take longer than 60 days, then the funds rolled over maybe be hit with a 10% early distribution tax. 

So, to keep things simple, if you’re going to do a rollover, make sure that you’re only doing one per year and make sure that you complete it within 60 days of initiating it. A great way to make sure you don’t break the 60-day rule is just to automate the transfer of funds electronically in what’s called a direct rollover. If you follow both of these rules, you won’t end up paying more than you have to to the IRS. 

#7: Not Naming Beneficiaries

roth ira beneficiary

Only two things in life are for sure, and that’s death and taxes. But, there is something that you can do before your death that could save your heirs thousands of dollars, and that’s naming a beneficiary on your Roth IRA. 

If you fail to name a beneficiary on your Roth before you die, then the amount in your account will go into your estate, which means that your heirs will have to go through the probate process to get access to it. And, without going too deep into what probate is, let’s just say that it’s kind of a nightmare. 

Your heirs will have to prove in court that your will is valid and all of your assets will have to be appraised and will be subject to taxes and fees. That means that they could very well end up having to wait a long time to get access to your money and they’ll probably end up getting a lot less than if you had listed them as a beneficiary. 

You should also make sure to review your beneficiary list regularly, especially if you recently got a divorce. If you and your spouse got a divorce, they will still receive money from your IRA if they’re listed as a beneficiary.

#8: Not Withdrawing Inherited Money

inheriting roth ira

The IRA recently announced a new 10-year rule that applies to beneficiaries of Roth IRAs. And it basically states that if you’re a beneficiary on a deceased person other than your spouse’s IRA, you have to withdraw 100% of that money from their IRA within 10 years.

So, make sure you mark on your calendar when that 10-year period is up because, if you fail to withdraw that money within 10 years, then the IRA may impose a tax of up to 50% on the money that was supposed to be withdrawn, which could be a ton of money. 

The good news here, though, is that you won’t have to pay any tax on the money you withdraw if you do it within 10 years and the IRA account is more than 5 years old. So, if you name beneficiaries on your IRA, make sure that they’re all aware of the 10-year rule. 

And, if you recently inherited an IRA, you should make sure to withdraw all funds left to you within 10 years or you’ll risk losing up to half of the money in that account.