Many taxpayers do not realize that there are certain age thresholds associated with retirement accounts that can impose hefty penalties when it comes time to file taxes. So, what are these penalties, and how can they be avoided?
The first penalty that can occur is the early withdrawal penalty. This penalty totals 10% of the amount withdrawn from the retirement account, and is imposed on individuals who withdraw retirement funds prior to reaching age 59 ½ . This is known as an early distribution. However, certain circumstances will qualify for a waiver of the penalty. Exceptions include, but are not limited to:
• Series of substantially equal payments
• Qualified higher education expenses
• First time home-buyer (up to $10,000)
• Tax levy
• Separation from service after age 55
For a full listing of exceptions to the 10% early distribution penalty, you may view the IRS guidance listed here: https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions.
The next penalty related to retirement distributions occurs at age 70 ½ and all subsequent years for those who have IRA’s or defined-contribution plans. Beginning at this age, participants must begin withdrawing a certain amount of their retirement funds, commonly referred to as the Required Minimum Distribution (RMD). This disbursement is calculated annually based on the prior year fair market value in the retirement account(s) and the participant’s life expectancy.
While determining the amount for distribution is not complex, many taxpayers often forget about this requirement and fail to withdraw the funds. For those who do not take out the RMD, a 50% excise tax on the distribution shortfall can be imposed. If this were to occur, the taxpayer may request a waiver of the penalty when reasonable cause can be established.
Planning for retirement is becoming increasingly important. As the retirement age and average life expectancy rises, there is great potential that some taxpayers will outlive their money. By remembering these key items about retirement distributions, penalties can be avoided which will allow taxpayers to extend the longevity of their retirement savings.