Making a living out of a nest egg can be tough, but breaking some important laws governing your retirement account can make things even more difficult.
One wrong step and Uncle Sam’s long arm may soon tap you on the shoulder and demand some clarification.
Below are the penalties you should absolutely avoid when contributing to or withdrawing from your retirement account.
1. Excess IRA Contribution Penalty
Building a large retirement savings is a noble goal. But donating too much to your personal retirement account (IRA) can be costly. According to the IRS.
This violation can be done in the following ways:
- Contribute more than the annual contribution limit applicable to the IRA
- Improper rollover to IRA
What if you made one of these mistakes by getting a little too enthusiastic about building nest eggs?
“Excess contributions are taxed at the annual rate of 6% as long as the excess remains in the IRA. Taxes cannot exceed 6% of the total value of all IRAs at the end of the tax year.”
How to Avoid Penalties for Excess IRA Contributions
The IRS offers remedies to correct mistakes before penalties are applied. By the time your federal income tax return is due for the year, you must withdraw the excess contributions and the income you earned on those contributions, according to the agency.
For example, if you made a large contribution to your 2022 IRA, you must withdraw the excess by April 18, 2023 to avoid penalties.
2. Early withdrawal penalty
Withdrawing money from your retirement account too early is another potentially costly mistake.
If you withdraw money from your IRA before you turn 59½, you may have to pay an additional fine of 10% on top of that money. IRS says.
The same penalties apply to early withdrawal from a retirement plan Like 401(k).
How to avoid early withdrawal penalties
The IRS notes that there are some circumstances in which early IRA withdrawals are permitted without penalty. for example, lose one’s jobare allowed to tap the IRA early to pay for health insurance.
Even retirement plans like 401(k)s have exceptions.
It is important to note that the exceptions that allow early retirement plan withdrawals without penalty may differ from the exceptions that allow early IRA withdrawals without penalty.
3. Missed RMD penalty
Retirement plans are great because they usually let you defer paying taxes on contributions and income for decades. Alas, Uncle Sam will eventually demand a share of that cash.
Previously, taxpayers were required to receive a minimum distribution (also known as RMD) from most types of traditional retirement accounts from the year they turned 72.
“The Secure 2.0 Act will raise that age to 73 from 1 January 2023 and to 75 in 2033.”
However, the consequences of not making these mandatory withdrawals still apply. According to the IRS:
“If you do not receive a distribution, or if the distribution is not large enough, you may have to pay 50% excise tax on the amount not distributed as appropriate.”
How to avoid missed RMD penalties
The best way to avoid this penalty is to withdraw on time and in accordance with IRS regulations.
However, if you want to avoid the hassle entirely, you can put all your money in a Roth IRA or Roth 401(k). RMD regulations do not apply to Roth retirement vehicles. You can leave money to Roth indefinitely.
There are two ways to make sure all retirement money is in Roth:
- Make direct annual contributions to a Roth IRA or Roth 401(k) and do not contribute to traditional deferred tax accounts.
- If you already have money in a traditional IRA or 401(k), convert it to Roth.
Not sure how to proceed? Stop by the Money Talks News Solutions Center to find a great financial advisor to help you.
4. HSA Contribution Penalty for Medicare Beneficiaries
If you’re used to making annual donations to your health savings account, you might be surprised that enrolling in Medicare stops you from doing that.
If you do not understand this rule and donate in error, you may be subject to 6% excise duty on the excess donation amount in addition to your income tax.
How to Avoid HSA Contribution Penalties for Medicare Beneficiaries
When it’s time to sign up for Medicare, remember that your days contributing to HSA are over.
As explained:
“If you sign up for Medicare during your first enrollment period (three months before you turn 65 and up to three months after you turn 65), you must complete your last HSA in the month before you turn 65. Contributions must be made to avoid penalties, and if you sign up within two months of the end of your first enrollment period, you can make your final HSA contribution in the month before you turn 65. , can also avoid penalties.”
If you wait to sign up for Medicare later, you can avoid penalties in one of two ways:
- Within 6 months of turning 65: Stop contributing to HSA the month before you turn 65.
- At least 6 months after you turn 65: Stop your HSA contributions 6 months before you apply for Medicare.
If you made a mistake and already contributed to the HSA when you shouldn’t have, you may withdraw your excess contributions and earnings and add them to your income on your tax return to avoid the 6% excise tax. there is. It must be done by the tax due date.
For more information on all of these, see 4 Types of Medicare Penalties and How to Avoid Them.
