Making Your Money Last

The IRS Cracks Down on IRA Mistakes

The penalties can be stiff if you make one of these common IRA errors.

EDITOR'S NOTE: This article was originally published in the October 2012 issue of Kiplinger's Retirement Report. To subscribe, click here.

Thanks to the quirks of the tax code, an IRA can quickly become a comedy of errors. But with the IRS now taking a closer look at IRA rule-breakers, mistakes in these accounts are no laughing matter.

The IRS is cracking down on common IRA missteps such as making contributions that exceed the annual limit and failing to take required minimum distributions. "We are developing a plan to reduce noncompliance with IRA contribution and minimum distribution requirements, and we are on track to complete it by October 15," the IRS said in a statement e-mailed to Kiplinger's Retirement Report.

Greater IRS scrutiny of IRAs "will catch a lot of taxpayers," says IRA expert Seymour Goldberg, an attorney in Woodbury, N.Y. As IRA assets have grown, reaching $5.2 trillion at the end of March, the Treasury Department has raised alarms about increasing numbers of taxpayers breaking IRA rules. In tax years 2006 and 2007, for example, nearly 300,000 individuals made excess contributions and roughly 255,000 failed to take RMDs, according to a 2010 report by the Treasury Inspector General for Tax Administration.

Penalties for such mistakes can be stiff. Taxpayers who forget to take an RMD, for example, can be dinged 50% of the amount they should have taken.

It's easy to make a mistake. Consider excess IRA contributions. In 2012, people age 50 or older can contribute $6,000 to a traditional or Roth IRA, or their taxable compensation for the year -- whichever is smaller. A person who makes the maximum contribution at the start of each year may lose his job and fail to meet the taxable compensation hurdle. Or a retiree whose only income comes from pensions and dividends may not realize that "compensation" generally refers to earned income such as wages. And you can't contribute to a Roth IRA if you're over the adjusted gross income limit -- $183,000 for a married couple in 2012.

In other cases, IRA owners may simply forget they've already made their IRA contribution for the year -- and make it again. One way to reduce this risk: Keep all of your retirement funds with one brokerage firm, says Robert Keebler, a certified public accountant in Green Bay, Wis. That way, the firm will likely tell you that you are doubling up on contributions.

A taxpayer can avoid the 6% tax on an excess contribution if he withdraws the excess cash -- and any earnings on that amount -- by October 15 of the year following the contribution. If you've made a Roth contribution that becomes excessive because you go over the income limit, you may want to recharacterize it as a traditional IRA contribution instead of simply withdrawing the amount, says Barry Picker, a certified public accountant in New York City.

Watch for Rollover Pitfalls

Rolling over assets from one IRA to another can also be a minefield. If you take the money from the first IRA and don't put it into the second IRA within 60 days, the distribution is considered taxable income. You can only do one rollover per 12-month period. A better option may be a "trustee to trustee" transfer, in which assets move directly from one financial institution to the next. You can do an unlimited number of these transfers.

Another common mistake is failing to take RMDs on time. You must take your first RMD by April 1 of the year following the year you turn 70½. Subsequent RMDs must be taken by the end of each calendar year. If you delay taking the first RMD until the year after turning 70½, you will need to take two RMDs in that second year. Consider asking your custodial firm to automatically calculate your RMD each year and transfer the amount to a non-retirement account.

If you accidentally skip all or part of an RMD, take the distribution as soon as you remember and file Form 5329, attaching a letter explaining why you believe you qualify for a waiver of the 50% penalty. Generally, the IRS has been generous in granting waivers to taxpayers who make a one-time RMD goof. But, Goldberg says, "don't wait for the IRS penalty to come down and then fumble for a reasonable excuse."

Haven’t yet filed for Social Security? Create a personalized strategy to maximize your lifetime income from Social Security. Order Kiplinger’s Social Security Solutions today.

Most Popular

Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
Should You Take an Extra Big RMD This Year?
required minimum distributions (RMDs)

Should You Take an Extra Big RMD This Year?

Sometimes only taking the minimum IRA distribution can be a costly mistake. When deciding how much to withdraw this year, you need to consider the big…
November 23, 2021
The Berkshire Hathaway Portfolio: All 41 Warren Buffett Stocks Ranked

The Berkshire Hathaway Portfolio: All 41 Warren Buffett Stocks Ranked

The Berkshire Hathaway portfolio is a diverse set of blue chips, and increasingly, lesser-known growth bets. Here's a look at every stock picked by Wa…
November 16, 2021


How 10 Types of Retirement Income Get Taxed

How 10 Types of Retirement Income Get Taxed

When you're planning for retirement, it's fun to contemplate all the travel and rounds of golf ahead of you, but don't forget about taxes.
December 3, 2021
12 States That Tax Social Security Benefits
social security

12 States That Tax Social Security Benefits

You may have dreamed of a tax-free retirement, but if you live in one of these states, your Social Security benefits may be subject to state taxes.
December 2, 2021
18 States With Scary Death Taxes

18 States With Scary Death Taxes

Federal estate taxes are no longer a problem for all but the extremely wealthy, but several states have their own estate taxes and inheritance taxes t…
December 2, 2021
What’s Your Retirement Number? Don’t Just Go by the 4% Rule
retirement planning

What’s Your Retirement Number? Don’t Just Go by the 4% Rule

To help make sure your retirement income covers your needs and lasts for a lifetime, you need a custom plan. The 4% rule of thumb is a handy starting…
December 1, 2021