The IRA Tax Trap
Retirees often experience unexpected income tax costs when withdrawing funds from their retirement accounts, sometimes due to missed required minimum distributions (RMDs).
Lack of attention paid to beneficiary designation may also prove surprising; similarly, there’s the absurd “one IRA rollover per year rule”, which serves no logical tax policy purpose.
Double Taxes on After-Tax Contributions
Rollover IRAs can be an excellent way to prepare for retirement, yet they’re vulnerable to punitive tax regulations. One common pitfall involves misunderstood requirements regarding “basis” tracking for after-tax contributions made into an IRA – failing which, the IRS may tax you when taking distributions later on in retirement.
As it turns out, direct trustee-to-trustee transfers are one way of avoiding this trap and moving your balance from your employer’s plan into an IRA directly. Otherwise, when receiving payments directly payable to you personally from your plan, 20% of any taxable portion must be withheld for federal income taxes; you’ll then have 60 days to save enough money in order to complete a completely tax-free rollover or you will incur the 10% early withdrawal penalty tax on all amounts received. It would be wise to consult an experienced financial planner about planning strategies regarding retirement asset withdrawal strategies before making decisions regarding retirement asset withdrawal strategies when withdrawing funds directly.
The IRA-to-IRA Rollover Trap
Over the past decade, IRA assets have seen explosive growth due to people rolling over distributions from employer plans into self-managed IRA accounts in an orderly fashion in order to avoid income tax ramifications.
An indirect rollover occurs when you receive your distribution by check and deposit it in your personal account before writing another check to your IRA provider within 60 days. This differs from direct transfer which involves filling out paperwork with your IRA custodian to request funds be transferred directly.
The IRS permits only one indirect rollover per year without incurring penalty tax, although there are ways around this absurd rule. One potential solution involves considering multiple distributions as part of one transaction as being treated as one rollover (see private letter ruling 2011-13047 ). Though unlikely, this shows that they might consider relaxing their once-per-year rule for special situations.
The IRA-to-IRA Transfer Trap
Rolling over your company retirement plan into an individual retirement account when leaving an employment is often tax-wise; however, it can also easily break a series of federal rules governing this rollover process and lead to penalties.
Simply stated, you have sixty days to move money from a company retirement plan into an IRA before it becomes taxable if cashed-in – although you are only permitted one indirect transfer every 12 months.
But consider this scenario: A man receives a distribution check from his CD bank that’s payable directly to him, but instead endorses it over to his IRA without cashing it. The IRS won’t know about this “Hail Mary” maneuver but will recognize its use, subjecting him to income taxes on 20% withheld and possibly early withdrawal penalty tax of 10% if under age 59 1/2. Although such “Hail Mary” maneuver can get around once-every-12-months rule (as discussed on Forbes column), the IRS haven’t extended this exception for these situations yet.
The IRA-to-IRA Withdrawal Trap
Withdrawals from an IRA made before age 59 1/2 are generally included as gross income and subject to a 10% penalty, with certain exceptions applying. If you’re in the military and called up for more than 179 days of active service, however, withdrawals of up to $10,000 from your IRA without incurring penalties can be made without incurring penalties.
When rolling over a distribution from one employer plan into another employer plan or an IRA, you have 60 days in which to complete it tax-free; otherwise, all amounts withheld from your distribution will be taxed as they were taken out at once.
Before they take Social Security benefits, many seniors pay no taxes at all by living off after-tax savings and Roth IRA accounts. But it is wise to tread carefully when accessing these funds as any misstep could lead to higher Medicare premiums or income taxes in the future.
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