One of the most important things you can do for your future is to open a retirement account and set money aside. Money in your retirement account can grow in a tax-advantaged way that can benefit you down the road. However, just because your retirement account comes with tax advantages does not mean that you are using it efficiently. Here are 5 retirement account mistakes that could cost you:

1. Early Withdrawal

One of the most costly mistakes you can make with your retirement account is early withdrawal. When you withdraw money early from your retirement account, you have to pay a penalty and income taxes on the withdrawal. That can turn out to be a rather hefty sum. On top of that, when you withdraw your principal, it’s no longer in your account, working for you. The future losses from not having the money in there can be almost as devastating as the penalties. There are some situations in which you can avoid a penalty for early withdrawal, but the principal is still gone.

2. Converting Your Traditional IRA to a Roth IRA

One of the big excitements for this year is the ability to convert a traditional IRA to a Roth IRA — no matter your income. However, this might not be the best idea. When you make the conversion, the amount that you move into a Roth will be subject to income taxes. You won’t have to pay an extra penalty, but you will have to pay taxes as if you were withdrawing from your traditional IRA. You can defer part of the hit, but it can still be costly.

3. Required Minimum Distributions

Once you hit the age of 70 1/2, you are required to take distributions from certain retirement accounts. These required minimum distributions (RMDs) can present a number of problems. First of all, some people forget to take them. Second, you have to calculate how much of a RMD is required in your specific situation. As a result, if you make a mistake, you may not take out the required amount. If you do not take your full RMD, you are subject to a penalty. (A Roth IRA does not carry a RMD.)

4. Borrowing from Your Retirement Account

Just as when you withdraw money from your account early, when you borrow money from your retirement account you are taking out principal that should be earning money for you. When your money isn’t working for you, you are losing out. Additionally, if something happens to your job, you might be required to (unexpectedly) repay the loan at once. Another issue is that you might not get your retirement account repaid in the required amount of time, triggering penalties.

5. Rolling Over an Inherited IRA

If you inherit an IRA, you can’t roll it over into your name — unless you are the spouse of the deceased. If you are a non-spouse inheritor, the money has to remain in the name of the deceased, and you are just the beneficiary. You can receive minimum distributions over time without tax penalty, but if you receive a direct distribution of the proceeds, or you roll over the IRA into your name, penalties could ensue. Make sure you get help understanding the rules from a qualified tax professional.

This article is featured on Carnival of Personal Finance



Miranda is freelance journalist. She specializes in topics related to money, especially personal finance, small business, and investing. You can read more of my writing at Planting Money Seeds.