5 Roth IRA Mistakes That Can Drain Your Retirement Savings

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Roth IRAs are an exceptional retirement savings tool, offering numerous benefits that make them a preferred choice for many investors. One of the most significant advantages is that qualified withdrawals during retirement are entirely tax-free. 

Planning for a secure and comfortable retirement requires careful consideration and strategic decision-making, especially when it comes to managing your Roth IRA. GOBankingRates asked experts to highlight five common mistakes that can have serious effects on your retirement savings.

Contributing Too Little or Too Much

“One common mistake is failing to contribute the maximum amount allowed to a Roth IRA,” says Firdaus Syazwani, founder of Dollar Bureau. “By not maximizing contributions, individuals may miss out on the opportunity to grow their retirement savings tax-free.”

As of 2023, the annual contribution limit is $6,500, or $7,500 for individuals aged 50 or older. Contributing this maximum amount consistently can lead to a substantial nest egg over time, providing you with a secure and comfortable retirement. 

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Conversely, you also are not allowed to contribute too much to your account without incurring a penalty.

Samantha Hawrylack, co-founder of HowToFIRE.com, says, “You need to make sure you don’t go over that amount or the IRS may impose a fine on you. Any funds over $6,500 will be subject to a 6% excise tax each year […] and doing that can be very expensive.”

Early Withdrawals

“Withdrawing funds from a Roth IRA before reaching age 59 1/2 can result in taxes and penalties,” says Syazwani. “While Roth IRAs offer flexibility and allow for penalty-free withdrawals of contributions (not earnings) at any time, early withdrawals of earnings can trigger taxes and penalties. You should always avoid early withdrawals by keeping your Roth IRA funds designated for retirement purposes unless otherwise necessary.”

Tim Schmidt, founder of IRAinvesting.com, says, “A buddy of mine, let’s call him Dave, once took an early withdrawal from his Roth. He thought he was penalty-free since he was only touching his contributions. But he didn’t realize that pulling earnings before age 59 1/2 would slap him with a 10% penalty. Ouch!”

To avoid touching the money in your Roth IRA, Syazwani recommends establishing an emergency fund to cover unexpected expenses.

Additionally, even if you are at retirement age, your Roth IRA account must be at least five years old before you can withdraw without penalties.

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Edith Reads, a senior editor at TradingPlatforms.com, says, “This means that if an individual opens a Roth IRA later in life, they may not be able to withdraw funds penalty-free until after they’ve reached age 59 1/2 and the account has been open for at least five years.” 

Lack of Diversification

As the saying goes, don’t put all your eggs in one basket. Diversifying investments is a crucial principle that lies at the heart of successful financial planning. 

“A key principle in any investment strategy is diversification,” says Bill Ryan Natividad, head of operations at Finty.com. “Some individuals make the mistake of not diversifying their Roth accounts, which can leave them vulnerable to the performance of a single investment or asset class.”

“Overconcentration in one investment exposes individuals to higher risks if that particular investment performs poorly,” says Syazwani. “We often recommend creating a diversified portfolio by investing in a mix of asset classes such as stocks, bonds and other investment vehicles. This diversification can help reduce risk and potentially enhance long-term returns.”

Forgetting To Update Beneficiaries  

Designating beneficiaries is a crucial aspect of financial planning that should never be overlooked. By doing so, you’re providing financial security to your loved ones. Regularly reviewing and updating beneficiary designations is equally vital, especially during significant life events like marriage, divorce or the birth of a child. 

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“Death and taxes are the only two certainties in life,” says Hawrylack. “But you can make a decision regarding your Roth IRA’s beneficiary before you pass away, which might save your family thousands of dollars. The money in your Roth account will become part of your estate if you don’t designate a beneficiary before passing away, in which case your heirs would have to go through the probate process to get it. Without getting too technical, let’s just say that probate is a bit of a nightmare. Additionally, especially if you just went through a divorce, you should make sure to routinely review your beneficiary list. Even after a divorce, your spouse will still be entitled to money from your IRA if they are specified as a beneficiary, which could be financially costly during retirement.”

“Regularly review and update beneficiary designations to ensure they align with your current wishes and estate planning goals,” says Syazwani. “Consider consulting with an estate planning attorney to ensure your beneficiary designations are properly structured.”

Not Making IRA Contributions for Your Spouse

Making IRA contributions for your spouse is a strategy that can enhance your overall retirement preparedness as a family.

“If one spouse doesn’t work, many people don’t realize that the working spouse can make contributions to a Roth IRA on behalf of the non-working spouse. This can effectively double your family’s retirement savings,” says James Allen, founder of Billpin.com.

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