Are you making mistakes with your money? Many people do, because of lack of attention, knowledge, confidence, or relying on the advice of friends rather than professionals.

If you’re getting ready to retire, have already or are changing jobs you are probably going to be getting one of the largest checks of your life, your lump sum distribution.  Fortunately there are not a tone of options

Mark Lund has put together a free report titled “The top 15 mistakes people make rolling over their IRA or 401(k) and how to avoid them.”  Here are four of the fifteen mistakes listed below.  For the full report just send us an e-mail or sign up for our newsletter.   

Mistake #1: Not doing a trustee to trustee transfer instead of a rollover. A direct rollover is not the same thing as a direct payment to you. Yes, your employer can actually write you a check for the full amount of your 401(k) account, but 20% of that money will be withheld for taxes.

If you don’t roll over the entire amount (100%), the amount not rolled over is taxable even subject to the 10 percent early-withdrawal penalty if you’re under 59 ½ (or under age 55 if the age 55 exception applies).  The 20 percent withholding tax requirement applies to rollovers from company plans to IRAs, but not to rollovers from IRAs.  Nevertheless, we still advise going the direct trustee-to-trustee transfer route because you avoid the 60-day rule and the one-rollover-per year limitation

Do you want to avoid that 20% withholding? A direct rollover (trustee to trustee transfer) is the solution. If it is a “trustee to trustee” rollover, which works like this: your employer writes a lump sum check not to you, but in the name of the trustee or custodian of the IRA that you are creating to hold the funds. You then let your company’s retirement plan administrator know that you’ll be doing a direct rollover. (There is almost always a form to be filled out, on which you can state the specific instructions for the distribution check.)

Your company sends you the check payable to the IRA trustee, with no withholding, and you have 60 days to deposit it in the IRA; day 1 is the day after you get the check. (Sometimes a wire transfer of assets occurs instead, between one investment custodian and another.) If you don’t complete the direct rollover in 60 days, you will pay tax on the entire amount. (There’s no grace period for weekends or holidays.)

If you want to leave work before age 59½ or you own shares of company stock, you should consider the tax implications created by those circumstances before attempting any kind of rollover.

Mistake #2: Naming a Trust as the Beneficiary of your IRA.   Where there is reason you may want to put your trust as the beneficiary this will in most cases cause more problems.  Generally speaking you should never name a trust as the beneficiary of your IRA, even if your attorney tells you to do it.  Trusts as IRA beneficiaries create unique problems and tax complications even when executed perfectly.  Basically speaking, if the trust fails to qualify as a designated beneficiary, then there is no designated beneficiary, and the trust beneficiary will not be able to stretch post death required distributions even over the surviving spouse’s life expectancy. In that case, the IRA will be paid out either under the five-year rule or over the remaining life expectancy of the deceased IRA owner.

Mistake #3: Making a prohibited transaction with your IRA money.  Periodically, people ask about buying real estate in their IRA.  So the question is, is this allowed and if so, is it a good idea or not. 

The first part of this question would be to understand a key component.  IRS Publication 590 defines prohibited transactions as “any improper use of your account”.   More simply stated, prohibited transactions, for IRAs, are those that would put the government at risk of never getting the tax on it.  To be clear, prohibited transactions only occur when funds within your IRA are used improperly.  You can always withdraw from your IRA, pay the tax (and penalty if you are under 59 ½ and no exceptions apply), and spend the money any way you wish, because now the government received their tax. 

The Internal Revenue Code specifically prohibits:

Buying selling or leasing any property to or from your IRA – this is considered “self-dealing.”  For example, you cannot have your IRA trustee (the financial institution holding your IRA funds) buy a building owned by your spouse and arrange to lease it back to your spouse. 

Buying property for personal use with IRA funds—you cannot use your IRA money to buy property that you (or your family) use personally—for example, a home that you use as your personal residence.  This is a prohibited transaction, even if you claim (as one wise guy did) that the home was to be a retirement home and since IRA money is retirement money, then using it to buy a retirement home should be OK. It isn’t, and he lost.

There are other problems with real estate in an IRA. 

What if you need to put more money into the property?  You’d better have enough of a reserve in your IRA to pay the annual property taxes and fund additional and sometimes substantial cash requirements for any maintenance.  You cannot just add more money to your IRA.  The only money that can be contributed to your IRA is the regular annual contributions and rollovers from other IRAs or company plans. 

Required Minimum Distributions at age 70 ½.  Even the Roth has RMDs when a nonspouse beneficiary inherits.  How will you be able to calculate RMDs?  What’s the value of your IRA?  Who knows?  With real estate, it’s anybody’s guess.  But if you guess wrong and withdraw less than your RMD, it’s a 50% penalty.

You would need an appraisal done at least every year once you begin RMDs even if it was owned by your Roth.  IRS requires Form 5498, “IRA Contribution Information.”

How do you distribute part of the real estate every year?

What if it is the wrong time to sell?

You would lose the tax deductions, such as depreciation and other property-related write-offs.  You cannot claim any of these if you owned the property in your IRA.

Real estate is traditionally a long-term investment and not as liquid as investing in stocks and bonds.  There is never a guarantee that your real estate will perform better than the stock market over the long term.  You should assess the amount of long-term risk you are willing to take with real estate. 

If the property is sold to provide income for the IRA owner’s retirement, the distributions will be taxed as ordinary income rather than as capital gains as would be the case for personally owned real estate.

If the IRA owner dies, the property will be sold and taxed to the beneficiaries as ordinary income.  Contrast this with personally owned real estate that would get a step-up in basis at the owner’s death and go to the heirs income tax free.

I am sure there are some good reasons to have real estate in your IRA but the big concern I would always have is if the IRS would consider my investment as a prohibited transaction.  Then I would have real problems. 

Mistake #4: rolling over plan distributions that are not eligible to be rolled over.  These include:

Required minimum distributions

Any distributions that are part of a series of substantially equal periodic payments or distributions over another specified period of 10 years or more (called Section 72(t) payments

Hardship distributions.  Some company plans may allow participants to withdraw to pay for a medical emergency, funeral, or other pressing need.  The reason that the IRS will not let you roll over hardship distributions to an IRA is because it feels that if you had such a pressing need for the cash, then the cash must be used for that pressing need.  In other words, the IRS saw this as a potential loophole and closed it.

Distributions to plan beneficiaries—except for spouse beneficiaries

We have included just 4 of the top mistakes people make.  If you or someone you know needs some help rolling over an old IRA or 401(k), just give us a call or shoot us an e-mail.