Retirement planning involves more than just saving—it’s about avoiding costly penalties that can erode your hard-earned savings.
Saving enough money for retirement is challenging, especially when unexpected tax penalties come into play. Many retirees end up with only a relatively small pool of money to live on, which can become even more complicated due to fluctuating markets and complex tax laws. Something as simple as an accidental misstep could cost you a lot of money in tax penalties. Here are five common penalties that can catch retirees off guard.
Contributing Too Much to an IRA
Saving aggressively is a great way to get ahead financially; however, exceeding the allowable limit for contributions to your Individual Retirement Account (IRA) can result in significant consequences. The IRS imposes a 6% penalty on any excess contributions that remain in the account at the end of the year. This penalty applies each year until the mistake is corrected.
To avoid this unhappy outcome, ensure you withdraw any excess contributions—and any earnings they generated—by the tax return deadline for that year. For instance, if you mistakenly contribute over the limit in 2023, you have until April 15 of 2024 to fix it.
Making Early Withdrawals
Accessing retirement funds before age 59½ can be costly. The IRS not only charges income tax on early withdrawals but also imposes a 10% penalty. This rule generally applies to many types of retirement accounts, including 401(k)s and IRAs.
However, there are exceptions that can help you avoid this penalty. For example, you may use your IRA funds to cover health insurance premiums if you lose your job. Make sure to consult a financial expert to fully understand the exceptions related to different retirement accounts. Each type of plan can have its own set of conditions, and a financial professional can provide guidance tailored to your unique situation.
Forgetting to Take Your RMDs
For those with traditional retirement accounts, forgetting to take Required Minimum Distributions (RMDs) can lead to significant financial penalties. Under the Secure 2.0 Act, the age for starting RMDs has been raised from 72 to 73, with the rule set to change again to age 75 in 2033. Failure to withdraw the required amount or neglecting to take an RMD altogether can result in a 25% excise tax.
If you realize the mistake within two years, correcting it can lower the penalty to 10%. To avoid these complexities, consider converting traditional retirement funds to a Roth IRA or Roth 401(k) accounts. The advantage is that RMD rules do not apply to Roth accounts. However, consult with a tax professional to determine whether this option is right for you.
Joining AARP for Exclusive Discounts
Approaching or already over 50? Joining the AARP can provide significant financial benefits, including exclusive discounts on travel, meals, healthcare, and much more. AARP membership costs just $15 in the first year, granting you access to savings that can positively impact your budget.
Benefits include discounted rates on various services, insider information about Social Security, job listings, and practical tools to help with retirement planning. Membership also grants access to the Fraud Watch Network, which helps you protect your money. To sign up
- Go to the AARP website
- Choose your free gift
- Click on “Join Today”
- Create your account to access discounts and resources.
Making HSA Contributions After Enrolling in Medicare
If you’re one of the many who have contributed to a Health Savings Account (HSA), bear in mind that once you enroll in Medicare, you can no longer contribute funds without facing a 6% excise tax. Many financial experts recommend halting contributions at least six months before applying for Medicare to avoid this hefty penalty. Many retirees inadvertently leave their HSA contributions set on automatic, leading to potential penalties.
Overlooking State-Specific Tax Laws
Many retirees fail to consider state-specific tax laws, which can impose additional penalties. These laws vary widely and can catch retirees off guard, especially if they've moved to a new state for retirement. It's critical to familiarize yourself with the tax rules in your new location. Meeting with a financial advisor or tax professional in your new state can help ensure you understand the relevant laws and requirements.
Bottom line: even the most proactive retiree can accidentally run afoul of tax codes. Consult a financial advisor or tax expert to ensure compliance with all federal and state tax laws regarding retirement. Hard work deserves a rewarding and stress-free retirement, so take the steps necessary to protect your nest egg from excess taxation.