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How to Avoid IRS Penalties on your IRA (Individual Retirement Account) Savings If you have savings accumulating in an IRA (Individual Retirement Account), you should be aware of some of the most common penalties and fees that you can be assessed if you make a wrong investment choice. We explain some of these penalties below: 1) Early IRA Distribution Penalty If you withdraw money prematurely from your IRA (if you are less than 59.5 years of age), this is known as an Early IRA Distribution. You will be assessed a 10% early distribution penalty on this withdrawal (on the gross amount). The IRS however does allow you to withdraw money prematurely from your IRA on special circumstances. For more on this, see Withdrawing Penalty Free Distributions from your IRA (Individual Retirement Account) If you fall under any of these cirumstances, be sure to have your IRA custodian or administrator sign and initial your Distribution Report. 2) Excess Annual IRA Contributions If you are below the age of 50, the maximum you can contribute to an IRA is $4000 in the year 2005. If you are over 50 years of age, you are allowed an additional $500 IRA Catch Up contribution thus totalling your max IRA contribution to $4500 in 2005. If you make any contributions in excess of this $4000 max limit, you must ask your IRA custodian to refund you this amount (without any earnings or interest on it) before your tax-filing deadline date. For instance, if you made an Excess IRA contribution in June of this year, you must remove this excess by April 15th, of next year. If you do not elect to remove this excess contribution, you will be charged a 6% tax for each year that the excess remains in your account. This 6% tax may not sound a lot but if you consider it for a few years, it does add up! 3) Minimum Required Distributions (MRDs) Penalty If you are over the age of 70.5, you must start taking Minimum Required 401k Distributions from your IRA account for each year after that age. Failure to do so will result in a 50% penalty. For example, if your Minimum Required 401k Distribution was $8000 in 2005 and you only distribute to yourself $6000, then you will owe 50% x ($8000 - $6000) = $1000 4) IRS Form 5329 Transactions such as buying your first primary residential home is exempt from the 10% Early Withdrawal Penalty. However, your IRA custodian may forget to mark the transaction as exempt from the 10% tax even though legally, it already is. If this happens, you must file IRS Form 5329 to claim this exemption. If you fail to file this form, you will be assessed the 10% tax. The IRS Form 5329 is available at http://www.irs.gov 5) IRS Form 8606 For every year that you make a non-deductible IRA contribution, or take an IRA distribution (withdrawal), you must notify the IRS by filling out the IRS Form 8606 which is available on the IRS website http://www.irs.gov Failure to fill out this form will result in you paying tax on your contributions. Failure to file the Form 8606 completely will result in a $50 penalty. Also be sure to correctly fill out the Form 8606 as any overstatements will result in a $100 penalty per each overstatement. |