The IRA Tax Trap

Many university employees save an important part of their income tax-deferred retirement accounts, but must be mindful that withdrawals could move them into higher tax brackets and significantly erode investment returns.

Rollovers should be conducted via direct trustee-to-trustee transfers; otherwise, 20% may be withheld to cover federal income tax; you must then come up with this amount within 60 days or face penalty taxes.


As people change jobs or retire, millions of retirement assets are moving from account to account – an activity which should be welcomed but may create tax issues down the line if handled incorrectly; such distributions from an IRA could have serious tax ramifications if handled incorrectly.

An indirect rollover requires taking two approaches; direct and indirect are equally effective ways of circumventing early withdrawal penalties and should only be undertaken as needed. A direct rollover requires having your plan administrator or IRA provider directly move distributions from old accounts into the new one without reporting or incurring taxes. A less common method involves receiving distributions via check and depositing them within 60 days into an IRA – in both instances the IRS withholds 20% for taxes which must also be deposited in order to avoid taxation – while an indirect rollover requires more paperwork as well as some human error potential than its direct counterpart.

Non-deductible contributions

Realistically, IRAs can quickly become an avalanche of tax problems. Although IRAs provide an envelope within which investments grow tax deferred, it could collapse should some important decisions be made that compromise that envelope.

One issue for investors is their failure to maintain accurate records of after-tax contributions. Income fluctuations make it easy to cross over from deductible to non-deductible IRA contributions and financial institutions don’t accurately reflect after-tax contributions on statements.

At the end of the day, if you fail to accurately track your after-tax contributions to an IRA, withdrawing it could cost twice. The IRS uses a “pro-rata” rule which determines which portion is tax-free; without proper records of after-tax contributions this calculation cannot take place, meaning you’ll pay taxes twice. Likewise if leaving your IRA assets behind.

Required minimum distributions (RMDs)

The RMD rule was created to help people prevent prematurely withdrawing too much of their retirement savings before it is necessary. For people over 73, it stipulates taking out an amount determined by taking their prior year-end account value divided by an IRS life expectancy factor; failure to do so incurs a penalty tax.

Though it can be tempting to allow your IRA funds to ride their course, it is crucial that you understand how RMDs operate in order to plan accordingly. RMDs count as taxable income and may push you into higher tax brackets.

Also, RMD calculations and withdrawals can be complicated. For instance, if you own multiple IRAs, their respective RMD amounts must be calculated separately before withdrawing them altogether to reach your total required amount. A financial advisor can help clarify these rules and develop strategies that reduce tax implications; such as using qualified charitable distribution (QCD). With QCD you can fulfill your RMD without incurring penalties.


Compliance with IRA rules can carry heavy fines for violations, but by following them carefully you can maximize the tax advantages of your retirement savings plan.

Slott: Naming primary and contingent beneficiaries can help your heirs stretch out distributions more evenly over time. In fact, designating beneficiaries could save them thousands in unexpected taxes. Benz:

Maintaining accurate beneficiary details at the financial institution holding your IRA or retirement plan account is also crucial, in order to avoid mistakes, legal battles and family strife. Consulting an experienced estate planner when making beneficiary choices could prove useful – they may offer insight into each option and their possible ramifications; may recommend additional measures that could avoid tax traps in an IRA account and assist in tracking non-deductible contributions and RMDs as needed.

Raymond Banks Administrator
Raymond Banks is a published author in the commodity world. He has written extensively about gold and silver investments, and his work has been featured in some of the most respected financial journals in the industry. Raymond\\\'s expertise in the commodities market is highly sought-after, and he regularly delivers presentations on behalf of various investment firms. He is also a regular guest on financial news programmes, where he offers his expert insights into the latest commodity trends.

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