Many Americans don’t save enough for retirement, but at least according to the IRS, it’s perfectly possible to save too much.
Tax law limits the amount you are allowed to donate to your retirement account, and overdonations may be punished. Uncle Sam also doesn’t want you to leave money in your account for a long time. People who fail to withdraw enough from their retirement account also face heavy penalties.
Here’s what you need to know to stay on the right side of the IRS rules:
Overcrowding your retirement account
Not everyone is allowed to donate to a retirement account. Donations to IRA or Roth IRA require that you or your spouse have “working income” such as wages, salaries, bonuses, commissions, tips, or self-employed income. Pension payments, social security benefits, rental income, interest and dividends are not counted. In addition, the ability to contribute to loss will be phased out with adjusted gross revenue of $ 125,000 to $ 140,000 for single filers and $ 198,000 to $ 208,000 for jointly filing couples.
People may not be aware that the annual limit on IRA contributions ($ 6,000 in 2021 and $ 1,000 catch-up contributions for people over the age of 50) is the limit for all IRA accounts. There is. That is, you cannot donate $ 6,000 to a traditional IRA and another $ 6,000 to a Roth IRA in the same year.
It can also make a significant contribution to workplace planning, such as a 401 (k), especially if you change jobs that year. Your new employer does not know if you have already made an annual limit-counted contribution to your previous employer’s plans (usually $ 19,500 in 2021 for people over the age of 50). Has contributed $ 6,500 in catch-up), says tax expert Mark Lascombe, chief analyst at Wolters Kluwer Tax & Accounting.
Even if you don’t change jobs, your 401 (k) contribution may be capped if you’re considered a “highly paid employee.” This is because low-paying workers are not fully contributing and own more than 5% of the company, earn more than a certain amount (currently $ 130,000), or rank by compensation. It can occur if you are in the top 20% of employees who have been. Excess donations will be returned as a check or other payment.
How to limit damage
However, it is usually up to you to discover and correct excessive contributions. Financial planner Robert Westley, a member of the American Institute of Certified Public Accountants’ Financial Literacy Committee, said that if a problem is found immediately, that is, before filing a tax return for the year, the excess is withdrawn to limit the damage. It states that it can be done. You also need to generate revenue from that contribution.
Withdrawals are taxed as income. Westley says that if the money comes from the IRA, if it’s less than 59½, you’ll have to pay an early withdrawal penalty of 10% on your earnings.
If the tax is overdue, a 6% penalty may be applied each year to the excess remaining in the IRA. Excess 401 (k) contributions can cause double taxation. Excess contributions and income are taxed at the time of withdrawal, but contributions are also added to the taxable income of the year in which the contribution was made, Westley said. Contact a tax expert to discuss your options.
Heavy penalty for not withdrawing enough
You don’t have to take a handout from a Roth IRA during your lifetime. However, other retirement accounts usually require you to start withdrawing the minimum amount after you turn 72. The age was 70 and a half, but it was changed by setting all communities under the Retirement Enhancement Act for those born after June 30, 1949. The first distribution must be done by April 1st of the year following the year of 72 years old. After that, it must be distributed by December 31st of each year.
If the deadline is missed or too low, the IRS penalty will be 50% of the amount that should have been withdrawn but not withdrawn.
If you’re still working at age 72 and your plan allows it, postpone the minimum distribution required until you retire from your current employer’s 401 (k), 403 (b), or other defined contribution pension plan. You can (5% or business details). However, even if you are working, you still need to start with a minimum withdrawal from your previous employer’s plan, IRA, and self-employed retirement plan, including SEP and SIMPLE.
After your death, safety law generally requires your heirs to empty their severance pay account, including a Roth IRA, within 10 years, but surviving spouses, people with disabilities or chronic illnesses, The exception is minor children or younger heirs, 10 years younger than the owner of the IRA account. (This is a new rule that applies to people who die after 2019.)
Again, the rules are complex enough that it’s worth consulting with a tax expert to avoid paying the IRS more than you need to.