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.

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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."
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