What Triggers Tax Penalties in Retirement?

Tax penalties
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Tax penalties can be especially stressful in retirement.

You have built your nest egg.

Now you are in or nearing retirement.

In retirement, you should have nothing to do but enjoy the fruits of your labors free from worry.

According to a recent Money Talks News article titled “3 Tax Penalties That Can Ding Your Retirement Accounts,” this assumption is inaccurate.

Tax penalties can cost your significantly in retirement.
Mismanaging your retirement funds brings significant tax penalties.

You still need to watch out for tax penalties in retirement.

Mistakes can leave you with a larger bill to the federal government.

What do you need to avoid?

Excess IRA Contributions

Saving too much money in your individual retirement account can lead to tax penalties.

This can be triggered in one of two ways.

First, you can simply contribute more money to the account than the applicable annual limit.

Second, you can complete an improper IRA rollover.

Although this mistake happens when you are still building your nest egg, the penalty can impact you in retirement.

How so?

The excess contributions are taxed at 6 percent each year the excess amount remains in the IRA.

The IRA tax cannot exceed 6 percent of the comprehensive value of all your IRAs at the end of the tax year.

If you have already contributed above the annual limit, you can withdraw the excess contributions and any income earned on those contributions before the due date for your federal income tax return to avoid tax penalties.

Early Withdrawal

Removing money from your retirement account before age 59½ can trigger a significant tax bill.

Your withdrawals from a traditional IRA will require income tax payments and a 10 percent penalty.

There are exceptions to this rule.

For example, those who lose their jobs can use their IRA to pay for health insurance without incurring tax penalties.

The IRA will also levy tax penalties on those who make withdrawals from their employer sponsored retirement plans.

Although there are exceptions to these penalties as well, they are not identical to those for IRAs.

The year 2020 held another exception in the CARES Act.

This act created a one-time exemption of the early withdrawal penalty for distributions up to $100,000 related to the coronavirus.

Missed RMD

Retirement plans can be especially beneficial during your working years because they allow you to defer paying taxes on the contributions and their gains.

Because taxes are differed, the federal government requires withdrawals to be made starting at a certain age so income taxes can be paid on the funds.

Prior to the SECURE Act, RMDs were to be made startling at age 70½.

After the passing of the SECURE Act in 2019, the age was moved to 72.

The tax penalties for failing to make proper withdrawals are steep.

You may owe up to 50 percent on the amount not distributed as required.

Although your Roth IRA may be held indefinitely without an RMD penalty, your heirs may need to be cautious if they inherit your Roth IRA.

Working with a financial planner can help you avoid tax penalties in your retirement saving and planning.

Reference: Money Talks News (Feb. 18, 2021) “3 Tax Penalties That Can Ding Your Retirement Accounts”

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