There is a lot of good information out there about individual retirement accounts. Quest Trust Company, for example, has published a great deal of valuable information and guidance about the pros and cons of the various account types, including the self-directed IRA, how to get started, and pitfalls to avoid.
But there’s also no shortage of misunderstandings that people have, as well some common IRA myths have been around for decades, it seems. The biggest problem with this misinformation is that it can lead people to make sub-optimal decisions regarding their accounts, or perhaps even to not open an account in the first place.
Here are three of the most common myths that you need to guard against.
It’s Not Worth Making Non-Deductible Contributions to an IRA.
Many retirement savers are initially drawn to IRAs because their contributions may be tax-deductible in the year they are made. This can be an extremely strong incentive to contribute, as it effectively gives the account holder and immediate “rebate” or return on their investment equal to the amount of their deduction.
The downside of this valuable benefit is that it can sometimes lead people to focus too much on the possibility of a deduction and not enough on the long-term benefits of the IRA itself. For example, Roth IRAs don’t allow deductibility of contributions, but all investment earnings and income within the account can be withdrawn tax-free during retirement. (With a traditional IRA, those withdrawals during retirement would be taxable.)
Even if you are not eligible to make contributions to a Roth account, making nondeductible contributions to a traditional IRA still provide a significant tax savings because of the tax deferred nature of investment earnings. Just keep in mind that you may want to set up a separate account for those nondeductible contributions, just to ease your administrative burden.
You Can’t Make Contributions to an IRA and 401(k) in the Same Year.
Another common misconception is that an individual cannot contribute to both a 401(k) and an IRA in the same tax year. This is simply not the case.
Both IRAs and 401(k)s have annual contribution limits, and your decision to participate in an employer-sponsored 401(k) may impact the type of IRA contribution you can make (deductible versus nondeductible) but you certainly can – and should – seek to maximize your IRA contributions each year.
Self-Directed IRAs Have No Investment Limitations
This myth is really only applicable to self-directed IRAs, but it’s an important one to understand. Self-directed IRAs provide individual investors with far more options than the IRAs that are available from traditional custodians. But there are IRS restrictions that apply to all IRAs (even self-directed IRAs), including prohibitions on self-dealing. For example, you can’t use your self-directed IRA to invest in a business that you draw a salary from, or to purchase art or collectible coins (even if your intention is to make those purchases for investment purposes).
The best way to make sure you understand all the important factors surrounding IRAs is to do your research.