written by Olivia Tinkler
Protecting the value of your individual retirement accounts (IRAs) and other retirement accounts is incredibly important. IRAs – both traditional and Roth IRAs – are among the most popular retirement savings vehicles today. There are many factors that affect the value of your retirement savings account and while some may be out of your control there are still many things within your control that can help safeguard the wealth of your accounts and further their growth.
The Treasury Inspector General for Tax Administration, which oversees IRS activities through investigative programs, came out with a report detailing an increasing number of taxpayers making common mistakes. These mistakes relate to failure to comply with IRA contribution and distribution requirements and are as follows, but not limited to: making excess contributions that are left uncorrected or failing to take required minimum distributions.
Making excess contributions
Understanding the contribution limits is imperative to avoid negative tax consequences; specifically, a six percent excise tax that applies to any excess contribution made to traditional or Roth IRAs. The contribution limits for the 2016 tax year are as follows:
- Traditional and Roth IRA – $5,500
- Traditional and Roth IRA, age 50 or older – $6,500
Did you contribute over the limit? No worries, as long as you withdraw the excess contribution amount before the due date for filing your federal return (including extensions) you will not be subject to the six percent excise tax. Earnings on the excess contribution must be withdrawn as well.
Not contributing enough
Personal and financial situations often dictates how much you will contribute to your IRA each year and whether or not you are able to contribute the maximum amounts. However, there are tax benefits to making the maximum contribution. A maximum contribution results in larger tax-free or tax-deferred growth opportunity for your account value upon retirement. In addition, contributing the maximum to your IRA means a larger tax deduction when it comes time to file your federal return.
Failing to rollover IRA funds within 60-days
If funds from an IRA are received with the intention to roll the money to another account, it is critical to remember you have only 60 days to do so in order to avoid paying additional taxes on the transaction. There are significant tax ramifications when failing to comply with the 60 day rule. The amount you intend to rollover is treated as ordinary income and subject to the applicable income tax rates. In addition, if you are under age 59 ½, you will be subject to an extra 10 percent tax. This does not include potential state income tax implications depending on your state of residence. There are few things to remember to help you avoid any additional taxes related to a rollover:
- Rollovers from traditional IRAs to Roth IRAs are always taxable, regardless of the 60 day rule.
- If the option is available, it is recommended you make a direct rollover or transfer of funds. This prevents you from ever directly receiving the money being transferred as it flows trustee-to-trustee, thus avoiding the 60 day ramifications all together.
- Generally, you are limited to one tax-free rollover in a 12-month period. Additional rollovers from the same IRA to another IRA could be subject to additional tax.
- Individuals age 70 ½ or older cannot rollover any required minimum distribution (RMD) amounts. If an RMD is required for the year, be sure to withdraw the amount prior to rolling over the related IRA.
Make Roth IRA contributions after age 70 ½
If you are continuing to earn income post age 70 ½, you can still contribute to your Roth IRA, on top of not having any RMD requirement. This could allow you to accumulate tax-free savings when you decide to withdraw the funds.
Failure to name an IRA beneficiary
If you have neglected to name a beneficiary of your IRA distributions from the IRA, they must generally be made as a lump sum or within five years after the owner’s death. Beneficiaries can include, but are not limited to, your spouse or child(ren).
There are many rules regarding distributions that depend on the beneficiary’s relationship to the account holder. It is highly recommended to discuss the various options with your trusted financial advisor in order to avoid unnecessary or unexpected complications for your designated beneficiary.
Roth IRA conversions
Converting a traditional IRA to a Roth IRA is dependent on many factors, included the financial and tax consequences of the transfer. When you convert, you are subject to income tax on the contribution. The amount transferred will be taxed at your ordinary income tax rate. Depending on your individual situation, it may be wiser to stick with your traditional IRA. Talk with your tax advisor and discuss your options in order to avoid and surprise taxes when filing your federal return.
Please contact our office if you wish to take tax advantage of your IRA account or if you have any questions 417-881-0145.