5 IRA Mistakes You May Be Making

This article provides information and education for investors. NerdWallet does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks or securities.

For some investors, IRAs may be long-term, hands-off investment vehicles. That doesn’t mean you should ignore them completely. This year, give a little love to your IRA and make sure you’re not making these common mistakes.

1. Not taking enough risk

We often talk about risk as a bad thing, but it isn’t always a four-letter word, financial advisors say. A young investor who isn’t planning to touch their IRA for 20 or 30 years should have enough time to weather near-term market swings, meaning they could take on more risk in exchange for potentially higher long-term returns. Advisors say such a portfolio could comprise mostly stocks — or even all stocks — instead of splitting the allocation between stocks and bonds. (Learn more about how to choose investments for your IRA.)

“When it comes to investing, the most powerful commodity is time. However, time is only useful if you know what to do with it,” says Dejan Ilijevski, an investment advisor at Sabela Capital Markets in Munster, Indiana. “Investing in an asset allocation that’s not right for you can be detrimental for your investment success over the long term.”

Simply put, too conservative of a portfolio now could potentially limit returns down the road, making it more difficult to hit your retirement goals. However, it’s equally important to rebalance your portfolio away from those riskier assets as you get closer to retirement.

2. Failing to fully fund your IRA every year

We get it. Long-term IRA investing isn’t as exciting as trading in a taxable brokerage account. But if you’re investing more in a taxable account without first maxing out your tax-advantaged IRA, experts might want a word with you.

By not fully funding your IRA first (that means contributing $6,000 in 2021 if you’re under 50 years old), you’re forgoing enormous tax advantages and the potential opportunity for that money to compound tax-free, says Robert Johnson, a chartered financial analyst and CEO at Economic Index Associates in Omaha, Nebraska.

“Too often people fail to realize the huge advantages of a tax-deferred account, instead investing in a taxable account,” Johnson says. “These advantages are greatest for those with the longest time horizons to retirement.”

Speaking of taxes, it’s also important to know the differences between traditional and Roth IRAs. In short, traditional IRA contributions are tax-deductible, while withdrawals are taxable. Roth IRA contributions are not tax-deductible, but withdrawals in retirement are tax-free.

3. Contributing slowly instead of all at once

In many cases, making regular contributions to your investment account — a strategy known as dollar-cost averaging — is sound advice. However, if you’ve got the cash, maxing out your IRA as early in the year as possible may be the way to go.

Any time a large amount of cash is involved, investing it incrementally over time may feel like the responsible thing to do. However, according to John Pilkington, a chartered financial analyst and senior financial advisor with Vanguard Personal Advisor Services in Charlotte, North Carolina, those positive feelings are generally the only benefit.

“Dollar-cost-averaging equates to taking risk later. While you may mitigate short-term regret, you’re more likely reducing long-term returns,” says Pilkington. “A better exercise may be reevaluating your asset allocation target relative to your risk tolerance.”

In other words, dollar-cost averaging could help you avoid the stress that comes from stock market volatility, but more often than not, it leads to lower long-term returns than lump-sum investing, Pilkington says. And if you’re still uneasy about investing all $6,000 upfront, consider a less-risky asset allocation — such as investing more in bonds — instead of spreading out contributions, he says.

4. Failing to explore your investment options

If you started an IRA by rolling over a workplace 401(k), you probably noticed you were no longer confined to the investments offered through your 401(k). This is a pretty big deal, and the influx of options shouldn’t go unnoticed.

“A lot of the IRAs I see are invested in a default investment option,” says James DesRocher, a financial advisor with Park Avenue Securities in Middleton, Massachusetts. “An advantage of an IRA is the flexibility you have of what to invest in. You can really dial in on a specific investment strategy that is tailored to you, and most people do not take advantage of this.”

5. Maintaining multiple retirement accounts

There’s no rule that says you can have only one IRA. As long as your annual contributions don’t exceed the limit, you’re free to disperse those contributions across any traditional or Roth IRAs you’ve opened. But that’s probably not a wise strategy, DesRocher says.

“Keeping multiple IRA accounts rather than consolidating into one very often leads to overlap,” DesRocher says, referring to investing in the same assets in different accounts. “It also takes away from the positive effect of rebalancing, which can reduce your overall risks.”

This goes for hanging on to old 401(k)s instead of rolling them over to an IRA, too. Not only will you avoid overlap and find more investment options with IRAs, but it’s also possible you’ll pay less in fees. (Learn more about how investment fees work.)

Source: nerdwallet.com

Traditional IRA vs. Roth IRA | Discover

Whether you’ve just started your first job or are well into your career, you’re likely to be focused on one key priority: building the best possible retirement savings plan for a comfortable future. No matter where you are in your journey, there are multiple options available to you and many factors to consider.

An individual retirement account, or IRA, for example, can serve as a turbo-booster for your retirement plan. As you save for retirement, it’s important to make sure you’re using the tax benefits of IRAs to your full advantage.

With two types of IRAs to choose from, you have a decision to make: Should you choose a Traditional IRA or Roth IRA?

Greg McBride, a chartered financial analyst and the chief financial analyst at Bankrate, and Brian Martucci, finance editor at financial education website Money Crashers, answer some of the most common questions around choosing a Traditional IRA vs. Roth IRA so you can make an informed decision.

Why contribute to an IRA?

Before we dive into the differences between Traditional and Roth IRAs, let’s review why IRAs are such an effective tool to save for retirement in the first place.

IRAs provide tax-advantaged ways to save for retirement. In other words, you may pay less in taxes when you use an IRA versus a personal brokerage account, which means you can enjoy a bigger nest egg in your golden years.

If you’re self-employed or don’t have access to an employer-sponsored account such as a 401(k), then an IRA can be your go-to account for building up your retirement savings while reducing your taxes. Even if you have a retirement account through your employer, you can supplement that savings with an IRA, a strategy many experts recommend.

Examine the difference between a Traditional IRA and a Roth IRA to determine which one is better suited to your retirement goals.

That’s because IRAs often offer a much broader field of savings and investment options than many workplace plans, Martucci notes. Possibilities within an IRA—whether you have a Traditional IRA or Roth IRA—include IRA savings accounts, IRA certificates of deposit, money market accounts and investments (e.g., stocks and bonds).

Plus, with longer retirements becoming common, a larger pot of savings can bring peace of mind. “If you can afford to make contributions and don’t need the money for day-to-day spending or shorter-term financial goals, why not do so?” Martucci says.

Am I allowed to contribute to an IRA?

As long as you earn income, you can contribute to an IRA to save for retirement. You’re also eligible if you filed taxes jointly with a spouse who has income from employment.

Anyone earning income can contribute to a Traditional IRA. Martucci notes that if you or your spouse are covered by a retirement plan at work, then you can only deduct your contributions from your taxable income if your modified adjusted gross income is within ranges specified by the IRS.

Before deciding whether a Traditional IRA or Roth IRA is right for you, make sure you're eligible to contribute to them.

To even contribute to a Roth IRA, you must meet certain income requirements. In 2020, for example, you had to earn less than $139,000 (if filing singly) or $206,000 (if filing jointly with your spouse) in order to contribute to a Roth IRA.

It used to be that Traditional IRA contributions were not allowed after age 70½, but the passage of the SECURE Act of 2019 changed that.

As of tax year 2020, there are no age limits for contributing to Traditional IRAs or Roth IRAs. You can start contributing—and keep contributing—throughout your life.

For the 2020 tax year, contribution limits stand at $6,000 per year before age 50 and $7,000 per year after age 50, but be sure to check the latest contribution limits defined by the IRS.

What’s the difference between Traditional IRAs and Roth IRAs?

When it comes to Traditional IRAs vs. Roth IRAs, they both have tax advantages. It’s the way their tax breaks work—as well as a few other nuances—that separates them.

Traditional IRAs: Deduct from taxes now, but pay later

If you qualify to deduct your contributions to a Traditional IRA from your taxes, then you’ll be happy to see a reduction in your tax bill. But Martucci explains that when you withdraw those funds from your Traditional IRA in retirement, those distributions are taxed as ordinary income.

One difference between a Traditional IRA and a Roth IRA is that with a Traditional, you can take a full deduction up to the amount of your contribution limit every tax year before you retire. You can take these deductions if your modified adjusted gross income is $65,000 or less (if filing singly) or $104,000 or less (if married and filing jointly).

Roth IRAs: Pay taxes now, but not in retirement

With Roth IRAs, it works the other way around. You contribute after-tax funds to a Roth IRA. When you withdraw from your Roth IRA account in retirement, however, you can do so tax-free.

Basically, McBride says, you will pay taxes one way or the other. With Traditional IRAs, you pay later. With Roth IRAs, you pay now.

Required minimum distribution (RMD) rules

Tax rules are an important difference between Traditional IRAs and Roth IRAs, but they also have different rules for when you are required to withdraw funds.

Martucci notes that Traditional IRA holders must begin withdrawing funds the year they turn 72.** Roth IRA holders, on the other hand, aren’t bound by RMD rules—an advantage if you don’t need the funds at that point.

Early withdrawal penalties

Because IRAs are designed specifically to help Americans save for retirement, there are withdrawal penalties designed to prevent people from pulling money out early from either a Traditional IRA or a Roth IRA.

If you withdraw money from a Traditional IRA before you’re 59½, you may get hit with an additional early withdrawal tax of 10% on the amount you withdrew—and that’s on top of any taxes you’ll need to pay.

With Roth IRAs, the early withdrawal rules are a little different. Because you already paid taxes on your contributions, you can pull them out of your Roth IRA penalty-free at any age. But if you withdraw any earnings on your contributions before 59½, you’re on the hook for the 10% early withdrawal tax plus income taxes. This is the case unless the distribution is considered a “qualified distribution” by the IRS.

Traditional IRA vs. Roth IRA: Which should you choose?

Before you stress out about making the wrong choice when comparing Traditional vs. Roth IRAs, McBride and Martucci want you to keep in mind that they are both wise choices. Either way, you’re taking advantage of tax breaks to save for retirement, and that’s a smart financial decision you should be proud of.

When debating a Traditional IRA vs. Roth IRA, your expected tax bracket in retirement should help guide the decision.

When deciding whether you should choose a Traditional IRA or Roth IRA, the general rule of thumb is to contribute to a Roth if you think you’ll be in a higher tax bracket in retirement than you are in now. If you think you’ll be in a lower tax bracket in retirement, conventional wisdom says you should contribute to a Traditional IRA.

However, McBride and Martucci agree that it can be difficult to predict what your future tax rate will be. That’s because tax rates often change, so you can’t assume they will be the same when you retire as they are today.

Because Traditional IRAs are bound by RMD rules, there is the possibility that those required withdrawals, which are considered income, could bump you into a higher tax bracket while in retirement.

“One of the advantages of a Roth is it helps people avoid having this big tax bomb in retirement because there are no required minimum distributions for Roth IRAs, and earnings from a Roth aren’t taxed anyway,” McBride says.

The bottom line? Don’t spend too much time worrying about how your future taxes will be affected by your IRA choice today. As long as you’re investing in an IRA—Traditional IRA or Roth IRA—you’re on the right track. Just try to avoid the common retirement mistake of putting off saving for too long.

Consider both a Traditional IRA and a Roth IRA

Still can’t decide between a Traditional IRA or a Roth IRA? Good news: You can use both types of IRAs.

“It certainly makes sense to have multiple IRAs for tax optimization and diversification purposes,” Martucci says. He notes that your annual contribution limit applies to the total of both IRAs combined.

If you use both, he recommends holding higher-growth-potential investments (such as individual stocks or exchange-traded equity funds) in your Roth IRA. On the other hand, he recommends holding lower-risk, potentially lower-return vehicles (such as municipal bonds or IRA savings accounts) in your Traditional IRA to avoid excessive taxes on withdrawals.

Now that you have a solid understanding of the differences between Traditional and Roth IRAs, you can confidently put your IRA accounts to work toward your retirement goals.

Your retirement might feel like it’s a long way off, but the sooner you can start the journey, the better. Explore the ways that Discover IRA Accounts can help you get there.

Articles may contain information from third-parties. The inclusion of such information does not imply an affiliation with the bank or bank sponsorship, endorsement, or verification regarding the third-party or information.

* The article and information provided herein are for informational purposes only and are not intended as a substitute for professional advice. Please consult your tax advisor with respect to information contained in this article and how it relates to you.

** Distributions are required to start by age 70½ if you were 70½ by 12/31/2019. If you turn 70½ in 2020 or years following, distributions will not be required until you are age 72.

Source: discover.com

What Is Financial Planning and Analysis (FP&A)?

What Is Financial Planning and Analysis (FP&A)?

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Financial planning and analysis (FP&A) is the process businesses use to prepare budgets, generate forecasts, analyze profitability and otherwise inform senior management decisions of how to implement the company’s strategy most effectively and efficiently. The FP&A functions can be accomplished by an individual or a team working alongside other finance professionals such as the controller and treasurer and reporting to the chief financial officer (CFO). While FP&A is often performed by people with an accounting background, it differs from accounting by focusing primarily on forward-looking information as opposed to historical data.

Typical members of an FP&A team include financial analysts and one or more FP&A managers charged with coordinating the work of the analysts. In larger organizations, a director or vice president of FP&A oversees the overall process and strategic direction and communicates with the CFO, CEO and members of the board of directors.

FP&A Functions

To fulfill its function of providing information and insight connecting corporate strategy and execution, FP&A performs a wide range of activities. These can be divided into a few broad categories including planning and budgeting, forecasting and management reporting.

The central output of the FP&A process consists of long- and short-term plans. The job requires using financial and operational data gathered from throughout the company. A key part of the FP&A process is collecting and combining a wide variety of figures from operations, sales, marketing and accounting departments to produce a unified view of the entire business that can guide strategy decisions by senior executives and board members.

Producing budgets is a big part of the FP&A planning function. Budgets describe expectations for the timing and amounts of arriving income, cash generation, disbursements to pay bills and debt reductions. Budgets may be monthly, quarterly and annually. Often FP&A creates a rolling budget for the following 12-month period that will be reviewed, adjusted and extended at the end of each quarter. FP&A also creates income statements and cash flow statements.

One of the performance reporting functions of FP&A is identifying variances when actual numbers reported by business units don’t match up to the budgeted amounts. In addition to identifying and quantifying variances, FP&A can offer recommendations for strategies that could be used to bring actual results in line with expectations.

Reports and forecasts from FP&A may be presented to the board of directors, to the CEO or other senior executives or to outside stakeholders such as lenders and investors. At a strategic level, decision makers use these analyses to choose how best to allocate the company’s resources.

Public companies reply on FP&A to provide shareholders and analysts with guidance on revenue and profits for upcoming quarters and fiscal years. The accuracy of the guidance supplied to the markets can have a sizable effect on stock prices.

Decision Support

Along with the ongoing responsibility to produce budgets, plans and forecasts, FP&A may also be called upon to support specific management decisions. For instance, it might analyze a merger or acquisition proposal to enable management to decide whether to pursue it or not. Other special projects delegated to FP&A could include analyzing internal incompatibilities and bottlenecks and making recommendations about how to improve the company’s processes.

Initiatives to find ways to trim costs and make a business more efficient are also likely to involve input from FP&A specialists. Because it is in constant communication with all areas of the company in order to gather data for its budgets and plans, FP&A is well suited to optimization efforts.

FP&A’s responsibilities could extend to nearly any department in the company, from operations to marketing to finance. For instance, FP&A may conduct internal audits, research markets or evaluate individual customer profitability. FP&A could also be called upon to provide risk management insights or assess the financial impact of tax policy decisions.

Bottom Line

Financial planning and analysis involves gathering financial and other data from throughout a business’s various departments and using that to generate projections, forecasts and reports to help executives make optimum business decisions. Annual and quarterly budgets and forecasts, profit-and-loss statements, cash flow projections and similar decision-making tools are all produced by FP&A.

Tips for Small Business Owners

  • Financial planning and analysis is a job best handled by an experienced financial advisor. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
  • The 80/20 Rule can help businesses gain insight into issues and opportunities so they can respond more effectively and efficiently. By identifying elements contributing most to a given outcome, businesses can better target resources to remove obstacles and exploit openings.

Photo credit: ©iStock.com/kali9, ©iStock.com/Maica, ©iStock.com/Korrawin

Mark Henricks Mark Henricks has reported on personal finance, investing, retirement, entrepreneurship and other topics for more than 30 years. His freelance byline has appeared on CNBC.com and in The Wall Street Journal, The New York Times, The Washington Post, Kiplinger’s Personal Finance and other leading publications. Mark has written books including, “Not Just A Living: The Complete Guide to Creating a Business That Gives You A Life.” His favorite reporting is the kind that helps ordinary people increase their personal wealth and life satisfaction. A graduate of the University of Texas journalism program, he lives in Austin, Texas. In his spare time he enjoys reading, volunteering, performing in an acoustic music duo, whitewater kayaking, wilderness backpacking and competing in triathlons.
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