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3 Costly Mistakes People Make With Roth IRAs – The Motley Fool

Roth IRAs continue to gain popularity as vehicles for retirement savings. That stems from the fact that the Roth IRAs offer tremendous tax breaks. Not only do they shelter your investments from capital gains tax and dividend taxes, but they allow you to withdraw your funds on retirement without paying them income tax.

However, taking full advantage of the Roth IRA means avoiding several mistakes that can cost you money in the form of taxes, penalties, and attorney fees. Here are three common and costly mistakes to be aware of and avoid.

 Money stuffed in an envelope marked

Roth IRAs come with the rules that need to be followed. Image source: Getty Images.

. Over-contributing

In 2019, workers under age 50 can contribute a maximum of $ 6,000 to a Roth IRA. People over age 50 can contribute a maximum of $ 7,000. However, if your income exceeds a certain amount, then you may not be able to contribute the full amount – or anything at all. To make the maximum annual contribution you must have a gross income of less than $ 122,000 if you are a single tax filer or $ 193,000 if you are half of the married couple filing jointly. The amount you can declare as your income exceeds these amounts. Once your income exceeds $ 137,000 as a single filer or $ 203,000 as a married couple filing jointly, you're not eligible to contribute to the Roth IRA at all.

If you contribute more to a Roth IRA than you're allowed, you 'll have made what is known as "an ineligible excess contribution," which can result in tax penalties. Specifically, the penalty for ineligible contributions is 6% of the ineligible amount. You pay this penalty when you file your income tax return using Form 5329. To avoid the 6% penalty for excess funds, it is important to know if you are eligible to contribute to the Roth IRA and how much money you can put in the account. each year based on your age and your income. Over-contributing is an easy mistake to make, especially if the recent increase in your income has suddenly made you ineligible to contribute the same amount you did before.

2. Pulling money out early

Pulling money out early can be a pitfall with many investments. But it can be especially costly if that investment is held in Roth IRA. If you withdraw money from a Roth IRA before you are 59 1/2 years old, the amount withdrawn may be subject to a 10% penalty, as well as income tax on any "accrued earnings." Any money you withdraw over the amount of your original contributions to a Roth IRA is viewed as "earnings," and it is subject to income tax.

The good news is that there are some notable exceptions to this rule. For example, if the funds go to buy your first home, or if they are distributed to your beneficiaries after your death, then withdrawal will not be subject to penalties or taxes. There are also some breaks available to people using a Roth IRA withdrawal to help pay college expenses. You must also remember the "five-year rule," which requires your Roth IRA to be open for at least five years before you withdraw any funds to prevent you from paying taxes and penalties.

Given the stiff penalties and taxes involved, It is advisable to withdraw money from the Roth IRA only as a last resort in an emergency. And bear in mind that the IRS has good reasons for putting these limits on your withdrawals: That money is meant to help you stay financially secure during retirement, not cover short-term expenses.

3. Forgetting to list primary and contingent beneficiaries

When you're setting up a Roth IRA, it's important to pay attention to fine print and fill out all forms and paperwork properly. This includes listing primary and contingent beneficiaries for the account. IRA may forge great pain for your heirs. The money in your account will be made payable to your estate, which means it will go through probation.

Remember to name beneficiaries when you first set up a Roth IRA and be sure to update the paperwork associated with the account. if you'd like to add or remove beneficiaries. For example, if you get divorced, you may want to remove your ex-spouse as a beneficiary, and if you have grandchildren, you may decide to leave some of the money to them.

Roth IRAs are great investment vehicles. But, like most retirement savings instruments, they come with their share of rules and procedures. Failure to follow the rules can lead to expensive problems.

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