Many of the best retirement savings strategies use employer-sponsored retirement plans, such as a 401 (k) or individual plans, such as an IRA or Roth IRA. These retirement vehicles offer credit protection, preferential tax treatment for investments and, in some cases, large tax deductions for contributions.
For example, when you save 401 (k), you can do it before tax, and you can pay up to $ 19,000 in plan deferral in 2019 and $ 19,500 in 2020. This amount is fully deductible and is not included in taxable income. Also, employer contributions of 401 (k) are not included in taxable income.
Make pre-tax contributions to traditional IRA accounts and pays withdrawal fees. The tax treatment is a little different, but it remains dominant for a Roth IRA. They are funded by after-tax cash so that investments can increase with deferred taxes, and if certain conditions are met, contributions and profits will be distributed without taxes.
The government wants to use the money in these accounts to withdraw and therefore places a number of limits and restrictions on the contribution of your account so that people cannot protect hundreds of millions of dollars in taxes without a real savings plan for retirement. Finally, the government wishes to obtain taxes on these investments and deferred tax savings. Secondary taxes can be applied to pension funds if you are not careful about the contribution or the withdrawal.
Let's take a closer look at the first three retirement fines and how to avoid them.
If you have an excess IRA contribution, you must pay a penalty of 6% of the excess each year that remains in your account. Traditional and Roth IRAs have restrictions to avoid over-contributions.
For Roth IRA accounts, your income determines your ability to make direct contributions.
Although you can contribute directly to an IRA after the age of 70.5 years, you can, however, gradually eliminate a deductible IRA contribution based on your marital status, from your participation in an employer-sponsored pension plan and your income level. Also, you can have excess contributions by transferring an ineligible reinvestment amount by transferring a required minimum distribution (RMD) or by contributing beyond the annual allocated amount.
The first thing to do before depositing money into a retirement account is to make sure that you meet the contribution requirements. But sometimes you make mistakes or forget that you have already contributed to the current year. What happens in the event of excess contributions?
So, let's say you contribute $ 6,000 to a Roth IRA in 2019, but you earn a lot of money to allow you to contribute legally. You have several options at this time. The best thing to do is to withdraw the money. What needs to be eliminated depends on the detection of errors. If you withdraw your money before deducting taxes, you will not pay the 6% penalty, but you may be charged a 10% penalty for taxable profits.
If you withdraw money after the tax reporting period, which is April 15 or October 15, including the extensions, you must withdraw the main contribution, but not the profits attributable to the excess tax. At this time, you must pay the individual tax of at least 6% for the first year and each year after that.
In some cases, you may have an excise duty of 10% if the total contributions for the excess exceed the annual contribution limit set for IRAs. However, there is no need to withdraw investment gains or pay excessive penalties.
Perhaps the best-known fine that applies to retirement accounts is the 10% early withdrawal tax. This penalty applies to distributions taxable in most tax benefit accounts if the distribution is made before the account holder is 59.5 years old. The idea behind this fine is to help keep the money in the pension plan.
For example, if you withdraw money from 401 (k) as a taxable distribution to pay college tuition fees at age 45, you will likely pay average income tax on the distribution, plus an additional 10% for retirement. This can be a significant tax scam, and you are running out of money if you are not careful.
That said, several exceptions allow for early distributions before 59.5 years and are not subject to an additional 10% penalty. For example, the death of the account holder and the disability exempt him from tax. For IRAs, this includes SIMPLEs, traditional Roth, and SEPs. You can withdraw up to $ 10,000 in taxable distributions for the cost of buying the first home without being subject to a 10% penalty.
The 10% exemption are not the same for 401 (k) if the IRA. You can withdraw from an IRA to pay for college fees, but you cannot use a 401 (k) for the same purpose and avoid the 10% penalty. You can withdraw money from an employer-sponsored 401 (k) pension plan or otherwise leave service with the employer during the year you are 55 or older. This means that if you had retired at 56, you could have received money directly from 401 (k) and would have avoided the 10% tax instead of having to wait 59.5 years. However, if you transferred 401 (k) to an IRA when you retired at age 56, you will have to wait for 59.5 before you can withdraw from the IRA and avoid the 10% penalty.
Finally, there is a strategy and an exception to the 10% fine, called substantially equal periodic payments. This allows anyone of any age to withdraw exempt money from a 401 (k) or IRA account, provided they do so with substantially equal periodic payments, lasting five years or up to 59,5 years. It's like creating income or a cash flow distribution almost similar to that of your account.
If you started at age 40, you should still receive annual payments of up to 59.5 years or almost 20 years. However, if you started at age 57, you must accept yearly payments for five or even 62 years. The SEPP calculation and rules are complicated, so consult a qualified financial advisor and a tax specialist before participating.
IRA, 401 (k) and other deferred retirement accounts are subject to the mandatory minimum distribution (RMD) after the owner turns 72 for those who have not reached the age of 70 at the end of 2019. Once, the SECURE Act had a drastic impact on the launch of the RMD. Roth IRAs are not subject to the same RMD rules as long as the owner is alive, but Roth IRA heirs are subject to the same RMD rules as IRAs and 401 (k) heirs.
Let's say you reach 20 in 2021. This means you need an IRA from your IRA by 2021. Take your IRA balance as of December 31 of the previous year and divide it by the appropriate IRS factor to determine the amount you need. Usually, such a distribution, whether it comes from an IRA or 401 (k) account, is taxable as regular income.
However, if you do not deliver the RMD on time, you will be subject to a charge of 50% for the amount of RMD that has not been received. The IRS has implemented self-healing and reporting systems to help repair lost RMDs. In general, it is recommended to improve the lost RMD by automatically extracting and restoring the IRS system. Because the RMD penalty is so high, you need to understand all the RMD rules and perform the correct RMD every year.
Remember that the exceptional tax is in addition to the regular income tax, which is likely due to any taxable portion of the RMD. If you lose an RMD with a 401 (k) contribution plan, you must also distribute interest or earnings on the lost RMD to remedy the problem.
Flynn Financial Group Inc