Tue. Jan 25th, 2022

Many Americans don’t save enough to retire, but it’s totally possible to save too much, at least according to the IRS.

Tax laws limit how much you can contribute to retirement accounts and excessive contributions can be penalized. Uncle Sam also doesn’t want you to leave the money in the account too long. Those who don’t get enough out of their retirement accounts also face heavy penalties.

This is what you need to know to stay on the right side of IRS rules.

Overflow your retirement accounts

Not everyone is allowed to contribute to retirement accounts. Contributions to an IRA or Roth IRA require that you or your spouse have “earned income,” such as wages, salaries, bonuses, commissions, tips, or self-employment. Pension payments, Social Security benefits, rental income, and interest and dividends do not count. In addition, the ability to contribute to a Roth gradually eliminates adjusted adjusted gross income between $ 125,000 and $ 140,000 for singles, from $ 198,000 to $ 208,000 for married couples filing together.

People may not realize that the annual limit on IRA contributions ($ 6,000 for 2021, plus a $ 1,000 recovery contribution for people 50 and older) is the limit of all IRA accounts. In other words, you can’t contribute $ 6,000 to a traditional IRA and another $ 6,000 to a Roth IRA the same year.

You can also contribute too much to a workplace plan, such as a 401 (k), especially if you change jobs during the year. Your new employer won’t know if you’ve already made contributions to your previous employer’s plan that would be accounted for for the annual limits (typically $ 19,500 for 2021, plus a $ 6,500 recovery contribution for people 50 and older) , says tax expert Mark Luscombe, senior analyst at Wolters Kluwer Tax & Accounting.

See also: Should I change my 401 (k) when I move to a new job and, if so, how? What do I need to know about moving retirement accounts?

Even if you do not change jobs, your 401 (k) contributions may be limited if you are considered a “highly paid employee.” This can happen if you don’t have enough workers with lower wages and you own more than 5% of the company, get more than a certain amount (currently $ 130,000), or if you are among the top 20% of employees classified as compensation . Your excess contribution will be refunded to you by check or other payment.

How to limit the damage

But it is usually up to you to discover and fix an over-contribution. If you spot the problem early enough (before you file this year’s tax return), you can limit the damage by withdrawing the excess contribution, says financial planner Robert Westley, a member of the Financial Literacy Commission of the United States. American Institute of CPAs. You will also need to withdraw the earnings attributable to this contribution.

Withdrawal will be taxed as income. If the money came from an IRA, you may have an early 10% withdrawal penalty on earnings if you’re under 59 and a half, Westley says.

Learn more: The penalty for early withdrawals

If you omit the tax deadline, a 6% penalty could apply for each year that the excess contribution remains in the IRA. An excess of 401 (k) of contribution can result in double taxation: the excess contribution and income are taxed when they are withdrawn, but the contribution is also added back to your taxable income for the year in which you made the contribution. , says Westley. Contact a tax professional to discuss your options.

The heavy pity for not retiring enough

You are not required to take distributions of a Roth IRA during your lifetime. However, other retirement accounts usually require you to start withdrawing minimum amounts after you turn 72. The age used to be 70 ½, but the Law setting each community to improve retirement changed it for people born after June 30, 1949. your first distribution before April 1, 1943 the year following the year he turns 72 years old. Then, distributions must be made annually before December 31st.

You miss a deadline or take too little and the IRS penalty is 50% of the amount you should have withdrawn but not.

I will see: How Much Can I Spend on Retirement?

If you are still working at age 72 and your plan allows, you can defer the required minimum distributions from your current employer 401 (k), 403 (b), or other defined contribution plan until you retire (unless you have 5%) or more of the business). Even if you are working, however, you should initiate minimum withdrawals from previous employer plans, as well as IRAs and self-employment retirement plans, including SEPs and SIMPLE.

After your death, the SECURE Act requires your heirs to empty retirement accounts, including Roth IRAs, within ten years, although there are exceptions for surviving spouses, people with disabilities, or chronic illnesses. , minor children or heirs under the age of 10 less than the owner of the IRA account. (This is a new rule that applies to people who die after 2019).

I will see: 3 tax breaks that most people miss

Again, the rules are complex enough to be worth consulting a tax professional to make sure you don’t end up paying the IRS much more than necessary.

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Liz Weston writes for NerdWallet. Email: [email protected] Twitter: @lizweston.

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