IRA Penalty Mine Field: Tread Carefully or Be Ready for Pain

IRA penalties are designed to stop individuals from abusing the tax advantages of these retirement accounts. The penalties are each designed with a specific purpose in mind. In general, all are aimed at assuring people are truly saving for retirement in an amount deemed reasonable by the IRS. Unfortunately, you do not get a say in how this is determined. You must simply follow the rules to avoid penalties against your account.

Yearly Contribution Maximums

Yearly contribution maximums are set to stop high-earning individuals from gaining too much benefit from the tax deductible status of an IRA. A low-income individual may not even be able to save the yearly maximum. He or she may have to stop far below this threshold in order to meet living expenses. A wealthy person could potentially contribute a huge portion of his or her salary. This would essentially penalize the lower earner. Instead, a percentage maximum is used up to a certain, maximum, dollar contribution. Once an individual has made the maximum dollar contribution, even if it is less than the allowable portion of his or her salary, that individual is not permitted to continue to gain tax deductions for contributing more. 

Early Distribution Penalties

You cannot withdraw funds from a retirement account until you reach the minimum age of 59 1/2. If you take a withdrawal before this qualifying age, you will have to pay the 10 percent early distribution penalty. There is no exception to this regulation. This is designed to stop people from contributing in order to gain the tax benefits but then failing to use the account for retirement. An IRA is not a savings account, and it cannot be treated as one without a large penalty.

Delayed Rollover Penalties

If you plan on rolling over your account to another option, you are permitted to do this within narrow guidelines. The rollover must occur either directly, transferring your funds straight from one IRA account into another retirement account, or within a short period. This law is designed to stop individuals from taking a distribution and disguising it as a rollover. For example, without a time line, a person could withdraw all the funds, make an investment for one year and later return the funds to a new account while keeping the investment profit. If an individual does not carry out a rollover within the narrow period allowed, that person will be charged a distribution penalty of 10 percent.

Excess Accumulation

When you are eligible to take withdrawals, you must begin taking them fairly soon thereafter. If you wait to begin your withdrawals, you may be subject to a penalty for excess accumulation in your account. In this case, you would be forced to withdraw the money, you would be taxed on the withdrawal and you would have to pay the additional penalty. The account begins losing money if not spent in retirement to stop wealthy retirees from passing these tax-deferred accounts onto their benefactors. This would be improper use of the designed purpose of the account, and it would favor high earners. 

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