If you are an educated retirement saver, then you are probably well aware of the 10% penalty you can get hit with if you take a withdrawal from your IRA or employer retirement plan before age 59 1/2. For many Americans–particularly those hit hard financially over the past 8 months–it can be tempting to take that early withdrawal to stay afloat. However, you’re a smart saver and you’ve most likely put yourself in a situation where you don’t need to hit your nest egg. That said, though, you should be aware of the exceptions to the 10% penalty. Now, I’ve mentioned these exceptions in the past, but I feel the need to mention them again as it’s been a while. There are a few exceptions, though, when you can take that early withdrawal and not have to worry about the 10% penalty. Buying your first home? Take that early withdrawal with no penalty. Want to help out a child with college tuition? Take that penalty free withdrawal. Lose your job and need help affording health insurance? Again, take the withdrawal and not worry about the penalty. These tend to be commonly used exceptions to the 10% early withdrawal penalty. Now, before you go taking huge early withdrawals from your retirement savings accounts, make sure it’s the right decision above all else. If you can get the funds you need from other places (ideally, an emergency savings account) that may be the wiser route to go. Remember, your retirement savings accounts should be an absolute last resort when it comes to taking early withdrawals. You should also meet with a certified financial planner or wealth manager to make sure you are making the best decision for you and your future and to ensure you take the proper steps when taking that early withdrawal.
Did you make an IRA contribution only to later find out that your were not eligible to make that contribution? Or maybe you made a contribution and later decided that you wanted to use that money elsewhere? Whatever the reason, just know that you can essentially take back a Roth IRA or Traditional IRA contribution, provided you file the paperwork for doing so on time. The deadline for correcting an IRA contribution is October 15 of the year after you made the contribution. That might seem like a random deadline, but I can assure you it is not. It’s exactly six months after the deadline for filing your taxes, which is the amount of time you’d get after filing applicable extensions anyways. Thus, the deadline for correcting 2018 IRA contributions is October 15, 2019. Now, if you want to make a correction, you will have two options: withdraw the contribution or recharacterize it. If you are considering correcting an IRA contribution, you should speak with a certified financial planner or wealth manager to make sure you do so properly and on time. Remember, if you don’t make the correction on time, you could face a 6% penalty for an excessive contribution.
It can be easy to forget about required minimum distributions (RMDs), especially as you move into retirement or if you inherit an IRA. Now, forgetting to take an RMD isn’t the absolute end of the world, but it should not be taken lightly. The penalty to missing an RMD is half the amount that was to be distributed, which is quite harsh and can be a substantial amount of money depending on the size of your retirement savings. So, what should you do if you forgot to take an RMD or you learned that you needed to take one from an inherited RMD? First off, withdraw the RMD out of the account as soon as you realize you need to take it. Next you will need to report the mistake to the IRS on the Form 5329, which can be filed along with your annual tax returns. On the form, make sure to report the RMD that should have been distributed, the amount distributed before the deadline, any reasonable cause amounts you would like waived, the penalty amount, and a letter explaining the reason for missing the RMD. Finally, and this is very important, do not pay the penalty until you hear back from the IRS with a denial or approval of your reason for the mistake. If your reason is denied, the IRS will then ask for payment of the penalty. As with anything involving the IRS, unless you are absolutely certain you know what you are doing, you should consider either hiring a financial advisor or tax professional to fill out and file your From 5329 so as to make sure it is done correctly. If you don’t want to have them actually file for you, you may want to at least consider talking to them during the process so as to make sure you’re doing things right. Remember, the key thing is that you correct your mistake as soon as you realize it and that you be honest with the IRS. Chances are your excuse won’t be accepted, but you will only have to pay the RMD penalty and nothing more. Missing and RMD is no laughing matter, but it’s not something you need to have a meltdown over, either. Just stay calm and do what you need to do!
A backdoor Roth IRA conversion can be tempting if you are considering retiring early and are currently over the income limits for a Roth IRA contribution. In case you are unfamiliar, a backdoor Roth IRA conversion is where you contribute money to a traditional IRA and then convert that money into a Roth IRA. This is a useful transaction for those who earn too much income to contribute to a Roth IRA as Traditional IRAs have no income limits. It’s also a perfectly legal transaction. However, when doing a backdoor conversion, keep in mind that the taxman will get his due and that this is not a way to avoid paying taxes on IRA contributions. The money you convert will most likely count as income and you will have to pay taxes on the money in your Traditional IRA that hasn’t already been taxed. It’s also important to understand how the IRS looks at your retirement funds. If you have more than one IRA, the IRS looks at the total of your IRAs and not just the IRA you make the conversion from. This can really pose a problem if you have more than one IRA with a large balance and may make you walk away from doing a backdoor Roth IRA conversion if the taxes are too high. Income limits are another important thing to understand when doing a backdoor Roth IRA conversion. Doing one backdoor conversion doesn’t mean you can start making regular contributions to the newly created Roth IRA. Rather, you will need to do a backdoor conversion every year that you are over Roth IRA income limits, which can potentially be for many years, especially if you are a high-income earner early in your career. That’s a lot of backdoor conversions and that can leave you open to the possibility of making more mistakes. A mistake on a backdoor Roth IRA conversion can be costly depending on the amount you convert and it can be as much as 6% of the conversion if you do so over the income limits. Since backdoor Roth IRA conversions are not particularly common and require a lot of thought, you should seek out the advice of a certified financial planner before doing one.
Missing a required minimum distribution (RMD) is not laughing matter. The IRS will not let you off with a slap on the wrist or a small fine. In fact, they can actually be quite harsh and can include up to 50% of the missed amount. However, you can request relief from the IRS, which may or may not grant that request depending on the circumstances. If you find that you missed an RMD, the first thing you should do is to withdraw the RMD money from your account as the IRS won’t even consider your request for relief. Once you take out the amount of the RMD, you will need to file a Form 5329, which you can do along with your tax return for the year that the missed RMD money was finally withdrawn or as a standalone document. Make sure that you properly fill out the Form 5329, which includes reporting the amount that the missed RMD was and the amount that you withdrew. If you are seeking relief from the penalty, make sure that you also note that on the form along with the total amount of the penalty you want waived. You will also need to attach a statement explaining why you missed the RMD, what you did to remedy the situation, and the steps you will take to prevent such a mistake from happening again in the future. Oh, and DO NOT PAY THE PENALTY! These steps can be tricky and you may want to do some Internet research on how to properly file a Form 5329. Ideally, though, you will speak with a tax or retirement expert as soon as you realize that you missed an RMD so that you can ensure that you follow the proper steps to remedy the situation.
If you have a lot of money saved up in an IRA, you may find yourself thinking about tapping into it before you need it. Maybe you had an emergency that requires some extra funds or your want to splurge a bit as you get near retirement. Whatever you decide to do with your money, just make sure it’s not prohibited by the rules governing IRAs. Prohibited transactions include those in which account owners act in a self-serving manner or in which the account owner uses the money to enrich himself/herself or other “disqualified person.” A disqualified person includes the accounts owner, the account owner’s spouse, any lineal descendants of the account owner, or people who help in the custodial care and maintenance of the account. In other words, the money in an IRA account should only be used to enrich the account itself and not people associated with it. So, if you want to clean out your IRA, go to Las Vegas, and go all-in on one poker hand with the hopes of doubling your earnings–which you would then put back into the account within the 60-day rollover window–then go right ahead. You won’t get in trouble for that. However, if you decide to invest $5,000 of your IRA in your child’s new business, then you’re really in for some trouble! It can be a fine line and what may seem like a harmless investment could open up a world of hurt for you and your finances. Prohibited transactions are not punished lightly as the tax-deferred status for the entire IRA is lost and the IRA is considered to be fully paid out. Furthermore, the entire balance of the IRA could be subject to tax and an early distribution penalty. That can be a heavy sentence, especially if you have a lot of money saved up. If you are unsure as to whether an IRA transaction you are considering is prohibited, you should speak with a certified financial planner or retirement specialist. If you are nervous about such a transaction, you’re better off erring on the side of caution and avoiding it altogether.
The rules surrounding retirement savings accounts can be complicated. As such, it’s not uncommon for people to make mistakes when it comes to saving for retirement. Luckily, the rulemakers realize this also and allow for corrections of many retirement savings account errors and mistakes. It should be noted however, that many mistakes are not penalty free, regardless of whether you correct the error in a timely fashion or not. However, taking the steps to correct an error can keep those penalties to a minimum and potentially save you thousands of dollars in both taxes and penalty fees. Furthermore, the corrective measures themselves can be complex and confusing, especially if you are not good with taxes. Again, though, putting the time and resources into correcting the error is most likely much more cost efficient than taking the penalty. If you have made an error with your retirement savings (i.e. made an excess IRA contribution) you will want to take steps to correct the error as soon as possible and as efficiently as possible. Your best bet to do so is by speaking with a certified financial planner or–if you already know that the correction will involve a tax hit–a tax professional who can help you properly calculate what the tax will be. This is also another good reason why you want to track your retirement account transactions and check to make sure they were processed within a reasonable time because once an error occurs there is only so much time to correct it before it becomes a costly mistake. If you have questions about your retirement account or think you may have made an error and want to correct it, again, you should speak with a certified financial planner and retirement expert.
Taking money out of your IRA is frowned upon in the retirement saving and financial planning industry. Not only does doing so lessen the amount of money you have for retirement, but taking money out early can put you are risk of incurring an early distribution penalty, which could result in you losing more money. The IRS has made exceptions, however, to the early distribution penalty because even the government realizes that life can be unexpected and place people in situations that may necessitate reaching retirement money. There are a number of exceptions to the 10% early distribution penalty, but today I am going to talk about only one: qualified medical expenses. In order to take money out of an IRA penalty free for a qualified medical expense three main criteria must be met: the medical expense must be more than 10% of your adjusted gross income (AGI), the expenses must be deductible under the Tax Code, and the expenses must be paid in the same year as the IRA or qualified plan distribution. While the these criteria may seem straightforward, they can still be confusing, especially when it comes to timing of the expenses and making sure that they match up with the year in which the distribution was made. If you are considering taking an early distribution from an IRA to pay for a qualified medical expense, you will want to speak with a certified financial planner or tax expert to make sure you don’t run afoul of the rules and end up with a penalty.
Thinking about taking an early distribution from your retirement plan and believe you can do so without getting hit with a penalty? You should be very, very careful in doing so. Yes, there are times when taking an early distribution is appropriate and you can avoid an early distribution penalty, but such situations are often few and far between. Aside from avoiding early distributions at all costs, you should really speak with a certified financial planner or retirement expert as part of the consideration process if you are fairly serious about doing so. While there are a number of ways you can take an early distribution without getting hit with a dreaded 10% penalty, it is also pretty easy to end up afoul of those exceptions and end up paying a hefty sum. The rules can be complex and if you don’t have a deep knowledge of how they work then you could be setting yourself up for trouble. This is why you need to speak with a financial professional who knows the rules and can provide honest and straight-forward feedback as well as make sure that you follow the proper rules should you find yourself in a situation in which you can take a distribution without the penalty hit. Those penalties can be somewhat hefty, especially if your distribution is a large chunk of money. Obviously you want to avoid the early distribution if possible, but if you do need to make one, be sure that you do so with all the knowledge and understanding possible.
It’s common knowledge among Roth IRA owners that if you make annual contributions to your Roth IRA, you can access those funds penalty-free at any time. It sounds simple, but people can forget that the rule only applies to annual contributions and that things can get tricky when it comes to converted funds. If you seek to access converted funds in a Roth IRA and are under age 59 ½, you must wait either 5 years before accessing those funds or until you reach age 59 ½. The holding period begins on January 1 for the year in which the conversion happened, which may be a win if you did the conversion later in the year (You don’t have to wait a full 60 months to access the money). This rule was created to prevent people under age 59 ½ from converting traditional IRAs to Roth IRAs and then immediately accessing the funds tax and penalty-free. Congress and the IRS just could not allow such a loophole that could deny them revenues. So now you might be wondering what the penalty is if the rule is not followed or broken? A violation of this rule could subject the Roth IRA owner to the 10% penalty the account owner would have to pay if they withdrew from their traditional IRA, which can be a hefty sum if there is a lot of money in the traditional IRA. Also, it should be noted that there is another 5-year rule for Roth IRAs that is centered around tax-free distributions of earnings from Roth IRAs, which is a different matter altogether.