Avoid IRS Nightmares: How to Dodge Excess Contribution Blunders

Stay on Top of Deadlines and Remember Your Required Minimum Distributions. Retirement plans and IRAs offer tax advantages for saving. In the case of Roth IRAs and Roth 401(k)s, earnings from contributions grow on a tax-deferred or tax-free basis. As tax season approaches, ensure you know all the necessary obligations.

Keep an Eye on Contribution Deadlines

The cutoff date for making contributions to an IRA or Roth IRA is the same as the tax filing deadline. It’s important to note that obtaining a filing extension for your tax return doesn’t grant an extension for IRA contributions. However, if you are a business owner, you can contribute to a qualified retirement plan until the extended due date of your tax return (e.g., October 17, 2024, for a 2024 contribution). If you missed this opportunity, you can still establish and fund a SEP IRA by the extended due date of your return.

Utilize Tax Refunds for Contributions

 If you get a tax refund, you can use it to contribute to an IRA or Roth IRA. This applies to the current tax year if you submit your tax return early enough for the IRS to direct the funds to your account’s custodian or trustee. Make sure to inform your custodian or trustee that you intend for the funds to count for the current year. If the funds arrive late or the intention isn’t communicated, they might be applied to the following year.

Resolve Excess Contributions: 

The maximum IRA contribution is $6,000 ($7,000 if you’re 50 or older); for 2024, it increases to $6,500 ($7,500 if you’re 50 or older). If you or your spouse are part of a qualified retirement plan at work, your MAGI could impact the deductibility of contributions to traditional IRAs.MAGI can also affect contributions to Roth IRAs regardless of other plans. Any excess contributions beyond your eligibility are subject to a 6% penalty each year until corrective action is taken.

In case of excessive contributions, prompt action is recommended. If you have made an excess contribution to a traditional IRA and realize the mistake before submitting your tax return, it is recommended that you withdraw the excess amount (along with any earnings) before the tax filing deadline to avoid a 6% penalty. If you’ve already filed your tax return, you can still correct excess contributions and earnings within six months by filing an amended return before the extended deadline in October. 

If this deadline is missed, remove the excess even after October 15 and decrease next year’s contributions by the excess amount.

Remember that withdrawing earnings from your IRA leads to ordinary income taxation, and if you’re under 59½ years old, you might face a 10% early withdrawal penalty.

Meet Required Minimum Distributions 

Understanding when to start taking required minimum distributions (RMDs) is important since tax deferral has limits. Failure to withdraw RMDs incurs a 25% penalty, a quarter of the required amount.

Roth IRAs don’t require RMDs during the account owner’s lifetime. You can leave the account untouched to grow tax-free for your heirs if not needed.

Individuals whose birthdates fall between 1951 and 1959 are obligated to commence taking their required minimum distributions (RMDs) from their accounts no later than April 1, following the year they reach the age of 72. Conversely, those born in 1960 or thereafter are required to initiate their RMDs by the age of 73. The specific RMD value is ascertained through IRS tables accessible in Publication 590-B, which vary based on factors including marital status and beneficiary circumstances.

Inherited Accounts

Regarding inherited benefits from retirement plans or IRAs, rules differ based on your relationship with the account holder. Surviving spouses have the option to treat the benefits as their own. Non-spouse beneficiaries typically have to take a distribution of the entire balance within ten years of the owner’s death.

Exceptions to the ten-year rule include minor children, disabled or chronically ill beneficiaries, and beneficiaries not more than ten years younger than the original owner. Relief might be available for missed RMDs if reasonable cause is demonstrated through Form 5329.

Early Distributions

Even if not mandatory, you may have taken distributions before age 59½ due to financial needs. Such distributions are usually taxable, and if you were under 59½ at the time, a 10% penalty applies unless an exception is met. During the 2020 pandemic, rules surrounding early retirement account distributions were temporarily adjusted.

The CARES Act permits qualified individuals to take a loan from their retirement accounts with certain provisions. The withdrawal is taxable, but taxes can be spread over three years. Recontributing funds within three years makes it nontaxable. The CARES Act also permitted delaying payments on prior outstanding retirement account loans.

Exceptions to the early distribution penalty exist, and proper documentation is crucial. For instance, disability or qualified higher-education expenses require supporting evidence.

New RMD Age 

SECURE 2.0, Section 107, raised the required minimum distribution age to 73, effective from January 1, 2024, to 75 from 2033. Those turning 72 after December 31, 2024, and before January 1, 2033, start RMDs at 73. Individuals turning 74 after December 31, 2032, will begin RMDs at 75.

IRA Deadline For Contributions

Generally, you have until the tax filing deadline, usually April 15, to contribute to your Roth or traditional IRA. You can contribute for the 2024 tax year until April 15, 2024. Contributions between January 1 and April 15 must specify the applicable tax year. For the tax year 2024, the IRA contribution deadline is Monday, April 18, 2024.

Correcting Excessive IRA Contributions

Excessive IRA contributions can incur a 6% penalty annually until corrected. Should you become aware of an excess contribution or an error before submitting your tax return, take the step to withdraw both the excess amount and any associated earnings. In the event that you’ve already filed, proceed to eliminate the excess earnings and submit an amended return prior to the extended deadline in October.

In Conclusion, retirement account regulations are intricate and subject to change. Seek assistance from your plan administrator, IRA custodian, or tax advisor to navigate these complexities effectively.