 |
It seems that some of the rules the IRS has put in place with regard to IRAs have not always been watched very closely – and the IRS is stepping up efforts to resolve some of this. According to the article in the WSJ, IRA Rules Get Trickier, an estimated $286 million in penalties and fees were uncollected for 2006 and 2007 tax years’ missed distributions, over-contributions, and the like.
The title of the article is a bit misleading, because the rules are not changing or getting “trickier”, the IRS is just going to be paying closer attention to what you’re doing with your account. This is set to begin by the end of this year, after the IRS delivers their report to the Treasury on how to go about enforcing the rules more closely.
The first rule being monitored more closely is the contribution rule – for 2012, you’re allowed to contribute the lesser of $5,000 or your earned income, plus an additional $1,000 if you’re over age 50. If you contribute more than the limit for the tax year, you will be subject to an over-contribution excise tax of 6% for each year that you leave the over-contribution in the account. Over-contribution can also occur if your income is above the annual limits for your particular IRA.
One way to resolve over-contribution is to simply remove the excess funds from the account. You need to make sure that you also remove any growth or income attributed to the over-contribution as well. Another way to resolve this is to attribute the over-contribution to the following year’s contribution. You would still owe the 6% excise tax for the prior year, but using either of these methods would get you back in shape.
Another rule is the minimum distributions rule. If you are over age 70½ and you fail to take the appropriate minimum distribution for a particular year, there is a 50% penalty applied for the amount not distributed.
Resolving missed minimum distributions is a bit more difficult than the over-contribution, which can be a problem for inherited IRAs as well as an IRA owned by someone over age 70½. This is especially true if you have missed more than one year of distributions, since each succeeding year depends upon the prior year’s distributions, and the calculations can get pretty messy. See Unwinding the Mistake in the article at the link for more on how this is done. (The article applies primarily to inherited IRAs, but the method is the same for all excess accumulations, i.e., not taking timely distributions.)
Neither of these rules has a statute of limitations, so if your account is in error by one of these rules, you should take steps to resolve it as soon as possible – delaying further will only increase the penalties and interest charges.
Sterling Raskie, MSFS, CFP®, ChFC®
The latest in our Owner’s Manual series, A 401(k) Owner’s Manual, was published in January 2020 and is available on 
A Medicare Owner’s Manual, is updated with 2020 facts and figures. This manual is available on 
Social Security for the Suddenly Single can be found on Amazon at 
Sterling’s first book, Lose Weight Save Money, can be 
An IRA Owner’s Manual, 2nd Edition is available for purchase on Amazon. Click the link to choose the 
Jim’s book – A Social Security Owner’s Manual, is now available on Amazon. Click this link for the 
And if you’ve come here to learn about queuing waterfowl, I apologize for the confusion. You may want to discuss your question with Lester, my loyal watchduck and self-proclaimed “advisor’s advisor”.
Question – Does the 50% excessive accumulation penalty count as part of the RMD?
Example: The IRA owner’s RMD for 2012 is $10,000. The IRA owner takes a $5,000 distribution on July 2, 2012. They fail to take the remaining $5,000 in 2012. This is realized on January 31, 2013 after receiving the 1099-R and discussing the situation with their IRA custodian. The IRA owner recognizes the need to fix this problem. Should the IRA owner take:
1 – the entire $5,000 in cash and wait for a bill from the IRS, or
2 – take $2,500 in cash and have $2,500 withheld?
In both 1 and 2 above the excess accumulation is removed from the IRA.
I realize this example has ignored income taxes that would need to be paid.
Question: In a TIRA with after tax money is the entire remaining distribution amount subject to the 50% penalty? Or just the taxable amount of the remaining distribution?
Clyde,
Regarding the distribution, either #1 or #2 will work. You’d want to make sure the tax return is filed correctly with form 8606 explaining the additional distribution for the prior year’s excess accumulation. In this case it would be the 2013 tax return filed in 2014, since that’s when the actual distribution occurs.
Regarding the second question, the entire distribution is subject to the penalty, otherwise if the entire IRA was made up of all after-tax money there would be no incentive to have required distributions.
jb
Great article to make clients and readers aware of this potential problem. The minimum distribution rules are especially draconian in that the penalty is 50%, yes, 50% of the required distribution.
Additionally, it important to not one important exception. Where the retirement plan is a corporate plan and the participant is not a 5% shareholder or owner, then the 70 1/2 trigger date is delayed until retirement, separation of service, etc.
Hope this helps your readers.
Another great point, Steven. One caveat to the exception: if the plan administrator chooses, this delay can be disallowed. It does happen sometimes, although not often.
Thanks for the input!
jb