How Many IRAs Do You Need?
By Laurey Shintani, June 21, 2022
Pop Quiz: What is the maximum number of traditional or Roth IRAs a taxpayer may establish?
Answer: There is no limit.
While taxpayers in 2022 are limited to contributing $6,000 per year (+$1,000 catch-up contributions for taxpayers age 50+) in total between traditional and Roth IRAs, it is permissible for consumers to establish an IRA with a new custodian (i.e., bank, brokerage firm, mutual fund, or insurance company) every single year. Add in rollovers/transfers and Roth conversions, and it is possible for consumers to have many IRAs and Roth IRAs with different institutions. A better quiz question might be “Why would you want to?”
A recently retired married couple, ages 69 and 67, came to Fee-Only Planning Hawaii seeking a comprehensive financial planning review. In our initial information gathering interview, the husband stated that he handled all of the investment management and that, in addition to seeking a review of all of the non-investment elements of their financial plan, he was seeking an objective second opinion of their portfolio to ensure they were prepared for the spending phase of their lives. They had been disciplined in saving over their working lives and had accumulated a respectable nest egg.
In the course of our review, we discerned that nearly all of their non-discretionary and discretionary living expenses would be covered by their pension and social security payments. They also had long term care insurance that would cover potential late retirement exogenous health care expenses. It was quickly obvious that, beyond RMDs, there was little need to tap their retirement savings. Without getting into the details of their investments or asset allocation, this was not a scenario that required the client to balance current distribution needs with portfolio depletion risk.
However, one finding that caught our attention was that they collectively held 9 individual IRAs along with a 401(k) account and two 457(b) plans. The IRAs were custodied at six different mutual fund companies. The also each had IRAs with Fidelity and the wife had one with Vanguard. When asked how this array of IRAs came to be, the husband explained that he used Morningstar for mutual fund research, and simply established IRAs with each mutual fund company he picked. The IRAs were sometimes funded with annual contributions and occasionally with rollovers pursuant to job changes. He said, the primary reason why they have so many IRAs was that he wanted their IRAs to be diversified.
From a financial planning perspective, maintaining this many retirement accounts creates unnecessary complexity. Sound financial planning would entail maintaining copies of 12 different beneficiary designation forms. In the event of the death of either spouse, the surviving spouse would have to go through the headache of contacting multiple institutions for spousal rollover paperwork. In the event of the simultaneous death of both spouses, their two children would have to settle 12 different accounts. Perhaps the biggest challenge of maintaining multiple IRAs, however, will occur when they reach the age at which they must each take RMDs (currently age 72). For the IRAs, each spouse will have to keep track of the RMD amount from each IRA. Although they may take the RMD from any combination of the IRAs, they must take their 457(b) and 401(k) RMDs separately. Overlook the RMD for one account or just make a mistake on your math and a 50% IRS penalty may apply.
Although the challenge of managing this many accounts is not insurmountable, the complexity is unnecessary and entirely curable simply by consolidating their respective IRAs and retirement accounts into a single brokerage IRA for each of them. In this instance, the husband was entirely unaware that his existing direct-held mutual funds could be consolidated in their Fidelity or Vanguard brokerage IRAs without incurring any fees or charges.
As it turned out, this extremely straightforward recommendation was a revelation to our clients. They delighted in the idea of each receiving just one set of statements, tax documents, and required disclosures. They also fully appreciate how this simple change dramatically streamlined their estate plan.
So How Many IRAs Do YOU Need?
The purpose of presenting the above case study has been to extoll the virtues of retirement account consolidation. For many people, the optimal number of IRAs is indeed just one. That said, there are certain situations in which it may be advisable to maintain more than one IRA. For instance, Hawaii has a unique tax law that exempts distributions from retirement accounts funded by employer money from state income tax while traditional IRA distributions and rollover distributions from salary deferral money are subject to Hawaii income tax. In this case, it may be advisable to segregate employer contributions in one rollover IRA and traditional IRA and salary deferral rollover money in another. Similarly, fixed and variable annuity contracts purchased as IRAs typically cannot be transferred to or consolidated with other IRAs without terminating the annuity contracts. It is also important to mention that contributory Roth IRAs and Roth conversion IRAs should typically be kept separate for at least five years after the initial conversion. In sum, “consolidate and simplify” is often sound financial planning advice with respect to the number of accounts one needs to optimize a portfolio, but, as with most elements of life, it is wise to be wary of absolutisms.