Certain transactions with retirement accounts can trigger penalties.
Retirement accounts like IRAs can be wonderful investment tools for your golden years.
Depending on the account, they can also provide tax incentives while you are working or while you are retired.
Because they are focused on helping you save for retirement and also have tax benefits, retirement accounts like IRAs are governed by specific rules.
According to a recent Money Talks News article titled “3 Tax Penalties That Can Ding Your Retirement Accounts,” breaking any of the rules will require you to pay penalties.
It is never a good thing to come to the attention of the authorities.
What are some common mistakes people make with their retirement accounts?
Making excess IRA contributions.
May you contribute their your income to an IRA and expect a tax credit.
Rather, the IRS has provided an annual contribution limit for IRAs.
Those who put too much into these savings and investment accounts or rollover funds improperly may be strapped with a penalty.
How large are these penalties?
Excess contributions will be taxed at 6 percent each year for as long as the amount in excess remains in the IRA.
The tax cannot exceed more than 6 percent of the combined value of your IRAs at the end of the year.
Generally, the IRS will provide the opportunity to remedy your mistakes.
How can one do this before the penalty is applied?
You can withdraw the amount of the excess contribution and also the income earned on the amount prior to the due date for federal income taxes for the year.
Taking money out too soon from a retirement account.
Because retirement accounts are meant to encourage saving for years when you no longer work, one incentive to keep the money in the account is to penalize early withdrawals.
But taking funds form the IRA prior to age 59½, you will owe both income taxes and a 10 percent penalty on the funds.
Some exceptions do exist.
The first is if you loose your job.
If so, you can use the IRA funds to make payments for health insurance premiums.
The 10 percent penalty also applies to other plans like 401(k)s.
Although exceptions to these withdrawal penalties exist, they may be different than those for the IRA.
After retirement, your retirement accounts can still be penalized.
For retirement accounts like traditional IRAs, there is a required minimum distribution to be taken annually.
As a result of the Secure Act of 2019, these withdrawals must be made starting the year a person turns 72.
Because these accounts defer taxes until withdrawals are made, the government wants you to remove money from these accounts and report it as income.
Neglecting to make required minimum distributions will bring high penalties.
Taking out less than the required amount or taking out no money at all will require you to pay a 50 percent excise tax on the amount you failed to distributed.
Although retirement accounts are certainly beneficial financial tools, you will need to be thoughtful regarding how you make your contributions and withdrawals to avoid IRS penalties.
Reference: Money Talks News (March 1, 2022) “3 Tax Penalties That Can Ding Your Retirement Accounts”