From contributions to conversions to distributions, don't fall into these traps.
By Christine Benz | 02-23-16 | 06:00 AM | Email Article

7) Not Contributing Later in Life 
True, investors can't make Traditional IRA contributions post-age 70 1/2. They can, however, make Roth contributions, assuming they or their spouse have enough earned income (from working, not from Social Security or their portfolios) to cover the amount of their contribution. Making Roth IRA contributions later in life can be particularly attractive for investors who don't expect to need the money in their own retirements but instead plan to pass it on to their heirs, who in turn will be able to take tax-free withdrawals. (Roth IRAs aren't currently subject to required minimum distributions, though President Obama's recent budget proposal included a provision that would impose RMDs on Roth IRA holders.)
Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

8) Not Gifting With IRAs 
Speaking of earned income, as long as a kid in your life has some, making a Roth contribution on his or her behalf (up to the amount of the child's income) is a great way to kick-start a lifetime of investing. Per the IRS' guidelines, it doesn't matter whether the child actually puts his or her own money into the IRA (there are, after all, movie tickets and Starbucks beverages to be purchased). What matters is that the child's income was equal to or greater than the amount that went into the account. 

9) Forgetting About Spousal Contributions 
Couples with a non-earning spouse may tend to short-shrift retirement planning for the one who's not earning a paycheck. That's a missed opportunity. As long as the earning spouse has enough earned income to cover the total amount contributed for the two of them, the couple can make IRA contributions for both individuals each calendar year. Maxing out both spouses' IRA contributions is, in fact, going to be preferable to maxing out contributions to the earning partner's company retirement plan if it's subpar. 

10) Delaying Contributions Because of Short-Term Considerations 
Investors--especially younger ones--might put off making IRA contributions, assuming they'll be tying their money up until retirement. Not necessarily. Roth IRA contributions are especially liquid and can be withdrawn at any time and for any reason without taxes or penalty, and investors may also withdraw the investment-earnings component of their IRA money without taxes and/or penalty under very specific circumstances, outlined here. While it's not ideal to raid an IRA prematurely, doing so is better than not contributing in the first place. 

11) Running Afoul of the 5-Year Rule 
The ability to take tax-free withdrawals in retirement is the key advantage of having a Roth IRA. But even investors who are age 59 1/2 have to satisfy what's called the five-year rule, meaning that the assets must be in the Roth for at least five years before they begin withdrawing them. That's straightforward enough, but things get more complicated if your money is in a Roth because you converted traditional IRA assets. This article describes the five-year rule in detail.

12) Thinking of an IRA As 'Mad Money'
Many investors begin saving in their 401(k)s and start to amass sizable sums there before they turn to an IRA. Thus, it might be tempting to think of the IRA as "mad money," suitable for investing in niche investments such an ETF that is set up to capitalize on falling energy prices or Brazilian inflation-protected securities. Don't fall into that trap. While an IRA can indeed be a good way to capture asset classes that aren't offered in a company retirement plan, ongoing contributions to the account, plus investment appreciation, mean that an IRA can grow into a nice chunk of change over time. Thus, it makes sense to populate it with core investment types from the start, such as diversified stock, bond, and balanced funds, rather than dabbling in narrow investment types that don't add up to a cohesive whole. 

13) Doubling Up on Tax Shelters 
In addition to avoiding niche investments for an IRA, it also makes sense to avoid any investment type that offers tax-sheltering features itself. That's because you're usually paying some kind of a toll for those tax-saving features, but you don't need them because the money is inside of an IRA. Municipal bonds are the perfect example of what not to put in an IRA; their yields are usually lower than taxable bonds' because that income isn't subject to federal--and in some cases, state--income taxes. Master limited partnerships are also generally a good fit for a taxable account, not inside of an IRA. 

14) Not Paying Enough Attention to Asset Location 
Because an IRA gives you some form of a tax break, depending on whether you choose a Traditional or Roth IRA, it's valuable to make sure you're taking full advantage of it. Higher-yielding securities such as high-yield bonds and REITs, the income from which is taxed at investors' ordinary income tax rates, are a perfect fit for a Traditional IRA, in that those tax-deferred distributions take good advantage of what a Traditional IRA has to offer. Meanwhile, stocks, which have the best long-run appreciation potential, are a good fit for a Roth IRA , which offers tax-free withdrawals. This article details the basics of "asset location."

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Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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