If funding retirement were easy, everyone would be doing it, right? Actually, funding retirement can seem easier than withdrawing your money. There are rules for both, and if you happen to make a mistake, you will have to pay penalties and fees to the government–after you determine how to resolve the issue at hand.
Let’s discuss some of the most common IRA contribution errors and how to avoid them. Then, we’ll discuss some of the most common IRA withdrawal errors, and how you can prevent them.
Unlike the stock market, there are caps on the amount of money you can contribute to your IRA each year.
For 2019, the total amount you can contribute to all your IRA accounts (doesn’t matter if it’s a traditional or Roth) is $6,000. This amount is an increase from the $5,500 level over the past few years. If you are 50 or older, you can contribute an additional $1,000 to catch up. Are you 70 ½ or older? You can no longer contribute to a traditional IRA but can contribute to a Roth IRA.
If you make less than the contribution amount this year, you can only contribute up to the amount you make.
What can you do if you realize that you have contributed excess funds?
- Prior to the due date of your tax return (typically April 15 of the following year, plus any extensions), withdraw all of the excess from the IRA.
- If there was any income earned on that amount, you will also have to withdraw this amount.
If you don’t do either of these, you’ll be taxed at 6 percent on the excess amount each year that you do not withdraw from your IRA account.
Roth vs. IRA Contributions
For many reasons, Roth and traditional IRAs are not created equal. One common error that people make is contributing to their Roth without realizing there is an income cap on contributions.
Here is the breakdown for the 2019 tax year based on modified adjusted gross income (MAGI):
- Single filer—$122,000
- Married filing jointly—$203,000 (with a reduced amount from $193,000 to the cap)
- Married filing separately—dependent on whether you lived with your spouse during the tax year or not
- If you did not live with your spouse—$137,000 with a reduced amount from $122,000
- If you did live with your spouse—a reduced amount from $10,000 to the cap
So, what can you do if you exceeded the contribution cap? Here are some options:
- Withdraw prior to filing your 2019 tax return
- Withdraw prior to October 15, 2020—you will likely have to file an amended return if you already filed, and you may have to amend your state return as well
- Withdraw and re-contribute the amount to the following tax year—if you do this, you’ll have to remember that your contribution limit is further capped by that amount next year
- Recharacterize the contribution from your Roth to your traditional IRA
- Do nothing and pay the 6% excise tax mentioned above
Required Minimum Distributions
Once you reach age 70 ½, you must start withdrawing a minimum portion of your traditional, simplified employee pension (SEP), or savings incentive match plan for employees (SIMPLE) IRAs. This amount is called a required minimum distribution, or RMD.
Worksheets are provided by the IRS and must be calculated each year for each account that you have. This does not include Roth IRAs.
For information on RMDs and how to avoid errors, you can read more here.
You don’t hear about this type of distribution often, but some banks will allow you to pledge (or collateralize) some of your IRA for a loan.