IRA Contribution Errors Can Cost Big if Not Caught Early

You must make all IRA contributions according to IRS regulation in order to avoid financial penalties against your account. Unfortunately, understanding the IRS's regulations can be confusing, which may result in errors to your contributions. You thankfully have time to correct these errors in order to avoid potential losses to your account from penalties. Look out for these problems, and fix them quickly if they do happen to arise.

Excess Contribution Penalty

Each year, the IRS caps how many an individual may deposit into an IRA. This is capped in two ways: as a percentage of income and as an overall limit. You can find the contribution limit by asking your plan administrator or contacting the IRS. If you happen to deposit more than the maximum contribution in any given year, you must correct the problem before you file your tax return. You have all year to make the correction, making it easy for you to transfer the funds to an alternate account. This much be done by April 15 of the following year, however, or the contribution is subject to a 6 percent tax penalty. To make matters worse, this tax remains as long as the funds are in the account. Therefore, the sooner you remove the funds the less you will be penalized.

Excess Accumulation Penalty

Once you reach the age of 59 1/2, you will have the option to begin taking money out of your IRA. You do not have to make any distributions, though, until you are 70 1/2. At that point, however, you must begin taking the distributions at a minimum amount determined by your required minimum distribution (RMD). This is calculated based on your life expectancy and the amount of funds in your account. You must take out your RMD each year. If you do not, the amount you should have taken out will be taxed at a 50 percent rate.

Non-Deductible Contributions

You may choose to contribute excess funds to your IRA as a means of saving, knowing you will not receive tax benefits. To do so, you will have to file Form 8606. This form tells the IRS how much you are contributing and allows the IRS to calculate the percentage of your account that is or is not subject to tax upon distribution. Failure to file this form results in a $50 penalty. Overstating your excess contribution amount results in a $100 penalty. Therefore, whenever you are making a non-deductible contribution, prepare the form well in advance and double check it for accuracy.

Penalty Abatement

If you have been penalized on your accounts and feel the penalty was incorrectly assessed, you must file a request for abatement of the penalty directly with the IRS. The most common reason for abatement is incorrect information supplied to you by the IRS. For example, if the IRS miscalculated your RMD when you inquired, you should not be penalized for excess accumulation. Save all documents you exchange with the IRS and send them with the abatement request. You will be notified in writing regarding the status of your penalty. 

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