Multiple IRAs: Why You Might Consider Diversifying Tax Benefits
As you move along your retirement-saving journey, you may find yourself having many types of retirement accounts.
In particular, it’s common to end up with multiple IRAs.
When you leave a job, you usually have the option to roll your old workplace retirement plan into an IRA. You can also open different types of IRAs on your own throughout the years.
There aren't any limits to the number of different IRA accounts you can end up holding.
But is there a benefit to having multiple IRAs? Or should you try to consolidate to just a couple of IRAs?
Here’s why you might want to consider having many IRAs.
Alternatively, you may find out why consolidating might be better for you.
Why Multiple IRAs Could Be Beneficial
Having multiple IRAs could potentially be beneficial if you look at it the right way.
Keeping up with many IRAs can take more effort. Even so, the benefits might outweigh that additional effort.
1. Diversify tax benefits with traditional and Roth IRAs
One of the biggest reasons to have multiple IRAs is diversifying your tax situation. The two major categories of IRAs are traditional IRAs and Roth IRAs.
In general, a traditional IRA allows you to contribute money to the account before you pay federal income tax on it. This tax deduction allows you to put more money into your account which will help it grow faster.
The money you invest grows without any immediate tax liability. When it comes time to take the money out of a traditional IRA in retirement, you have to pay taxes on both the contributions and earnings.
The other main option is a Roth IRA. The Roth IRA allows you to put money into the account today, but you don’t get any tax break today. The money can grow tax-free.
When you’re ready to take the money out in retirement, you generally get to take the money without paying taxes on it.
Since these two different types of IRAs offer very different tax benefits, it may make sense to have both.
You can have some traditional IRA money and some Roth IRA money available to you in retirement.
The best part:
Based on your tax situation in any given year, you can decide which account it makes more sense to pull money out of.
Or, you could take some out of each account depending on your needs.
Make sure you’re allowed to contribute to these accounts before you invest. You’ll need to check based on your particular situation and your adjusted gross income.
2. Take advantage of expertise and different investment options
Tax benefits aren’t the only reason to open multiple IRAs.
In some cases, you may want to open many IRAs. You can do this to take advantage of different firms’ expertise, products or services.
Opening an IRA account with one firm focused on real estate to invest in their real estate investment trust (REIT) product may be a great investment.
At the same time, you may want to invest in traditional stocks, mutual funds, ETFs or bonds that the company does not offer.
In this case, opening an IRA with a real estate focused company and another IRA with a traditional brokerage firm can give you access to the best of both worlds.
You can access the specialized real estate firm’s expertise and REIT products for a percentage of your retirement funds.
Then, you can invest another portion of your funds with the traditional brokerage firm that is better suited to handle your traditional investing needs.
Diversify your withdrawal options
The type of IRA you hold can influence the options you have to withdraw money from them.
While you can take money out penalty-free after reaching age 59 and ½, your options for taking out money before that age vary depending on if you have a traditional or Roth IRA.
Traditional IRA withdrawals before age 59 and ½ are generally subject to both taxes and a 10% early withdrawal penalty with certain exceptions.
On the other hand:
Those who hold a Roth IRA can access some of their money before reaching age 59½ without paying the early withdrawal penalty.
In particular, you can withdraw your contributions to your Roth IRA at any time without paying taxes or penalties. The reason you can do this is because you’ve already paid taxes on this money.
Earnings on those contributions are another story. You generally have to pay a 10% early withdrawal penalty if you take earnings out of your Roth IRA.
One notable exception exists for those that have had their Roth IRA for at least five years and use up to $10,000 toward the purchase of their first home.
Simplify beneficiary designation
When you die, the money in your IRAs will typically transfer to the beneficiaries you name on your IRAs.
If you want your IRA assets to pass to many beneficiaries, you can set up many beneficiaries on one single IRA account.
If you have specific investments you want to leave to particular family members, it can be tricky to do this with IRA beneficiary designations.
In these scenarios, it might make more sense to keep separate IRAs that each hold what you want a beneficiary to receive.
There is no question as to what investments each beneficiary gets when you pass away. They only get the assets in the IRAs they are listed on.
Diversify where funds are held and get more insurance
While you hope the company that holds your IRA never goes out of business, it is possible.
If your IRA is in a deposit account, it may qualify for FDIC insurance.
If your IRA is in a brokerage firm, your IRA may be covered by SIPC insurance. It’s important to note SIPC insurance doesn’t cover the loss in value of securities due to market prices.
However, if your firm fails, it covers you from investments that may turn up missing from your accounts.
These types of insurances have dollar limits based on your account types and institution. If you exceed these insurance limits, opening accounts at several institutions can usually get you more coverage.
Hopefully, you never have to deal with these issues, but it is good to be protected just in case.
Easier to leave money to charity
If you want to leave money to charity, doing it through a traditional IRA could be a smart move.
Charities don’t have to pay income taxes on money or investments given to them through a traditional IRA when you die.
The money never ends up being taxed at all.
If you want certain investments to go to particular charities, you can set up an IRA with just those investments and list the charity as the sole beneficiary.
Alternatively, you can set up a single IRA with all of the money you want to go to charities then list multiple charities as beneficiaries if you prefer.
This way, the charity money is kept separate from the money you want to go to your heirs. There should be no confusion if you set up a separate IRA for your charitable giving goals.
Why Multiple IRAs Might Be a Financial Nightmare
While multiple IRAs may have some benefits, the setup can come with downsides.
Keeping track of multiple IRAs can be a major headache.
You have to keep up with several accounts, statements, plan documents, investment options and more. Just the paperwork alone could drive someone crazy.
Once you start thinking about your retirement investing as a whole, having many IRAs can make things even more complex.
Ideally, you target a specific asset allocation based on your risk.
When you have multiple IRAs, you need to combine all of your account values to see if you have achieved your ideal asset allocation on a regular basis.
There is software to help with this, but it isn’t always 100% accurate.
Contributions are combined toward the annual limit
Having many IRAs doesn’t increase the annual contribution limits.
The annual limit across all IRA accounts is the same no matter how many traditional and Roth IRAs you have.
When you retire, managing many accounts could get confusing.
Thankfully, you don’t have to take required minimum distributions (RMD) from each IRA when you turn 70 and ½.
Instead, you can aggregate all of your IRAs’ values. Then, you could take an RMD from a single account or a combination of whichever IRAs you wish.
Potential additional costs
Finally, don’t forget to monitor the fees you pay.
Each IRA may have its own set of fees you must pay on an annual basis to keep the account open. Some IRAs may waive these fees if your balance is over a certain amount.
If you find your separate IRAs are costing you a substantial amount of fees, it may make sense to consolidate them.
This way, you can pay less in fees which should help your retirement savings grow faster.
Do What’s Best for You
Ultimately, you need to do what is best for you.
Your tax advisor or financial advisor may be able to help you figure this out for your situation.
Keep in mind that your advisor may have an incentive to have you move all of their money to them. This could be the case if they are paid through commissions.
That’s why it is smart to talk to a fiduciary financial advisor that is paid on an hourly basis. This way, commissions have no impact when discussing where to keep your money.