What to do if you are saving too much for retirement
Many Americans don’t save enough for retirement, but it’s entirely possible to save too much, at least according to the IRS.
Tax laws limit the amount you are allowed to contribute to retirement accounts, and excess contributions can be penalized. Uncle Sam also doesn’t want you to leave the money in the account for too long. Those who do not withdraw enough from their retirement accounts also face heavy penalties.
Here’s what you need to know to stay on the safe side of IRS rules.
OVERLOAD 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 income. Pension payments, Social Security benefits, rental income, and interest and dividends do not count. In addition, the possibility of contributing to a Roth gradually decreases with adjusted adjusted gross incomes of between $ 125,000 and $ 140,000 for single filers, from $ 198,000 to $ 208,000 for married couples filing jointly.
People may not realize that the annual IRA contribution limit – $ 6,000 for 2021, plus a catch-up contribution of $ 1,000 for people 50 and over – is the limit for all IRA accounts. In other words, you cannot contribute $ 6,000 to a traditional IRA and an additional $ 6,000 to a Roth IRA in the same year.
You can also over-contribute to a work plan like 401 (k), especially if you change jobs during the year. Your new employer will not know if you have already contributed to your previous employer’s plan, which would count towards the annual limits (generally $ 19,500 for 2021, plus a catch-up contribution of $ 6,500 for people aged 50 and over), explains tax expert Mark Luscombe. , Senior Analyst at Wolters Kluwer Tax & Accounting.
Even if you don’t change jobs, your 401 (k) contributions may be capped if you are considered a “highly paid employee”. This can happen if there aren’t enough lower paid workers and you own more than 5% of the business, earn more than a certain amount (currently $ 130,000), or are part of the 20% of the business. top-ranked employees by compensation. Your excess contributions will be returned to you in the form of a check or other payment.
HOW TO LIMIT THE DAMAGE
But generally, it’s up to you to find and settle an excess contribution. If you catch the problem early enough – before you file your tax return for that year – you can limit the damage by removing the excess contribution, says financial planner Robert Westley, member of the American Institute’s Commission for Financial Literacy. of CPA. You will also need to withdraw any income attributable to this contribution.
The withdrawal will be taxed as income. If the money comes from an IRA, you may owe a 10% early withdrawal penalty on earnings if you’re under 59 and a half, says Westley.
If you miss the tax deadline, a 6% penalty could apply for each year the excess contribution remains in the IRA. An excess 401 (k) contribution can trigger double taxation: The excess contribution and income is taxed when withdrawn, but the contribution is also added to your taxable income for the year you made the contribution, says Westley. . Contact a tax professional to discuss your options.
THE HEAVY PENALTY FOR NOT WITHDRAWING ENOUGH
You are not required to receive distributions from a Roth IRA during your lifetime. However, other retirement accounts generally require that you start withdrawing minimum amounts after age 72. The age was previously 70 and a half, but the Setting Every Community Up for Retirement Enhancement Act changed it for people born after June 30, 1949. You must take your first distribution before April 1 of the year depending on the year you turn 72. After that, distributions must be made every year before December 31st.
Miss a deadline or take too little, and the IRS penalty is 50% of the amount you should have withdrawn but didn’t.
If you are still working at age 72 and your plan allows it, you can defer the required minimum distributions from the 401 (k), 403 (b) or other defined contribution plan from your current employer until you retire. (unless you own 5% or more of the business). However, even if you are working, you need to start making minimum withdrawals from previous employer plans as well as IRAs and self-employed retirement plans, including SEPs and SINGLES.
After your death, the SECURE Act generally requires your heirs to empty retirement accounts, including Roth IRAs, within 10 years, although there are exceptions for surviving spouses, people with disabilities or chronic illnesses, minor children or heirs who are no more than 10 years younger than the owner of the IRA account. (This is a new rule that applies to people who die after 2019.)
Again, the rules are complex enough that it’s worth consulting with a tax professional to make sure you don’t end up paying the IRS much more than you need to.
This column was provided to The Associated Press by the personal finance site NerdWallet. The content is for educational and informational purposes and does not constitute investment advice. Liz Weston is a columnist at NerdWallet, a certified financial planner and author of “Your Credit Score”. Email: [email protected] Twitter: @lizweston.