Unintentional IRA Taxes to Avoid

By: Clay Wyatt

If you invest in an IRA, you probably do so because your money will not be taxed until you retire. Paying IRA taxes on it now would defeat the purpose of having an IRA. However, the IRS just loves to make life complicated, so there are some taxes that they can hit you with if you are not careful. The following are some unintentional IRA taxes to avoid.

Taxes on a 60 Day Rollover

If you intend to rollover a pension plan, 401(k) plan or another IRA to your current IRA plan, you can do so on an IRA tax free basis. You'll still have to pay taxes on it once you withdraw the fund eventually, but that won't happen until retirement (hopefully).

Of course, there are rules for doing such a rollover. Among other unintentional IRA taxes to avoid, there is a tax for those who do not complete the rollover within 60 days. Failure to complete a rollover within 60 days will result in the money being taxed and may also incur a 10 percent penalty if under age 59 1/2.

As this is one of the unintentional IRA taxes to avoid, you may wonder how to properly go about completing a rollover into your IRA. The best way is to do a trustee-to-trustee transfer in which your previous custodian transfers the money directly to your current custodian. You'll never touch the money and won't have to worry about getting it to your current account on time. Contact your current custodian to initiate this process if you'd like to go this route.

If you end up getting a check for whatever reason, do not cash it. Instead, speak with your financial advisor and/or current custodian and make sure that it gets deposited into your rollover IRA within 60 days of the date on the check. Otherwise, the tax man will have his hand out and you'll probably have to pay up. There are waivers to such taxes and penalties, but do you really want to count on the IRS to sympathize with you?

IRA Tax on Inherited IRAs

If you plan to pass on your IRA to someone else after you pass away - a good idea if you don't want Uncle Sam to get his hands all over it - there are a few unintentional IRA taxes to avoid. A key member of such unintentional taxes to avoid is the estate tax. This won't cost you any money, but could cost your beneficiaries a substantial amount of money.

Make sure that you have a named beneficiary on your IRA and never leave it to your estate. Let's assume your beneficiary is age 40. He will be able to inherit your IRA and will be allowed to have it continue to grow. He will be forced to take IRA minimum distributions but very small amounts over 42 years. This allows the tax deferral of your IRA to work powerfully for your beneficiary over a long period. If you name your estate as IRA beneficiary, the IRA must be withdrawn and taxed all within 5 years.

Conclusion

There are plenty of unintentional IRA taxes to avoid out there. As with any matter involving retirement planning, it is best to consult a financial advisor before hammering out any plans. There are simply too many taxes, loopholes and traps out there for those who are not absolutely sure of what they are doing.