Avoid common financial pitfalls for a more secure future.

In life and matters of the wallet, rest assured that we all make mistakes. Mistakes are a critical part of our education process – but when it comes to your finances, some lessons and consequences can be quite lasting. In an effort to help you learn from others, and potentially save a great deal of money and heartache, you may wish to review some of the following most common financial mistakes, and ways to avoid or mitigate them.

1. Cashing out a retirement account to pay-off loans. The Great Recession (and now the Great Pause) has forced many people to tap into retirement accounts in order to pay mounting bills and loans. This may be a measure of last resort, but many people are unaware that there may be substantial income tax penalties for withdrawals before a certain age. For example, the amounts an individual withdraws before reaching age 59½ are called “early” or “premature” distributions which may be subject to an additional 10% early withdrawal tax. (As always, there are some exceptions to this rule, so consult with a qualified accountant, financial advisor or the IRS.) Even if there are no penalties, cashing out an entire account at once may potentially put you in a higher tax-bracket. The moral of this story is to avoid taking a lump-sum distribution without speaking to a financial or tax advisor first. It’s best to understand all the tax implications up front and make a plan for withdrawals to reduce the impact if possible. Keep in mind, in 2020, withdrawal penalties will be waived for withdrawals up to $100,000.00 if affected by Covid-19.
2. Missing Retirement Account Rollover Dates. A typical rollover deadline is 60 days if you have taken a retirement account distribution by check. That means that you have roughly two months to deposit that money into another qualified retirement account and avoid possible tax penalties. It’s important to know that 401(k)/403(b) distributions have a required 20% Federal tax withholding. Therefore, if the withheld amount is not “rolled over” within that 60-day timeframe, that amount is taxed as a distribution. And according to a tax law change from a few years ago, now you are only able to process rollovers this way once per year; it becomes a taxable event if attempted again within one year. The lesson here? Rollover your accounts using a trustee to trustee transfer whenever possible.
3. Failure to update beneficiaries on accounts, insurance and in wills. It’s entirely possible to forget that a former spouse or deceased loved one is named as a beneficiary on retirement accounts, insurance policies and in your will. This could result in failing to provide for children, a new spouse or other loved ones. The moral of this story is to avoid disinheriting beneficiaries by checking designations annually and whenever a major life transition occurs (such as a marriage, divorce, birth, etc.).
4. No will. If you do not have a will, in the event of your death, the laws of intestacy determine who will receive your assets. Drafting a will helps you maintain control on these important matters. The take away? Speak with an attorney to discuss preparing a will that documents where you want your money to go when you’re gone and names beneficiaries, guardian, etc. Once it’s drafted, review it every few years and at major life transitions to make sure it’s updated and reflective of your wishes.
5. No Power of Attorney. A Power of Attorney (or POA) is an important document that allows your selected “point person” (often a spouse or trusted family member) to make decisions on your behalf. For example, your selected POA can access your finances and help keep up with bills, medical expenses, and tax returns. If you do not have a POA in place, and you become incapacitated, someone must petition courts for a conservatorship. This process often takes months, can cost thousands of dollars, and thus compounds the financial pressure. The lesson here is to speak with an attorney to discuss a POA, and while you’re at it, discuss a health care proxy at the same time. A health care proxy will allow a designated person to make medical decisions on your behalf, should you be unable to convey your wishes.
6. Single-life only pension. Many people often take the highest pension option available. They don't realize that upon death, unless there is adequate life insurance to cover income needs, the living spouse may end up relying solely on social security income. There are a number of reasons why people choose the single-life option, including, thinking that you will outlive a spouse; or that the spouse does not need the income; or even that it would be crazy not to take the full amount offered to you. This is an irrevocable decision, and although no one can predict the future, you may want to consult with a financial advisor together to discuss the pension options and income needs.

Sources and Resources:
IRS IRA Information:
https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions

Healthcare Proxy:
https://www.medicareinteractive.org/get-answers/planning-for-medicare-and-securing-quality-care/preparing-for-future-health-care-needs/health-care-proxies

Heidi Clute, CFP^® of Clute Wealth Management in South Burlington, VT and Plattsburgh, NY, an independent firm that provides strategic financial and investment planning for individuals and small businesses in the Champlain Valley region of New York and Vermont. For informational purposes only. LPL Financial does not offer legal or tax advice. Securities offered through LPL Financial, Member FINRA/SIPC.