IRS Cracks Down on IRAs

August 6th, 2012

While IRAs can be a great way to build up savings tax deferred, they also are fraught with traps for the unwary.  Penalties apply when an individual contributes to an IRA more than the Internal Revenue Code permits or fails to take the required minimum distribution.  IRS is turning its attention to IRAs that are out of compliance and should be paying penalties.

IRAs vary between traditional, Roth, and those funded with individual contributions vs. IRAs that contain roll overs of tax qualified employee retirement plan distributions.  Each type of IRA is subject to its own rules.

The Internal Revenue Code caps maximum contributions to IRAs.  For instance, this year the maximum contribution (other than roll over contributions) is $6,000.  However, depending on income, age, and marital status, your contribution limit could be less.  In addition, while all  IRA contributions were tax deductible at one time, they are not anymore.  If you or your spouse participates in a tax qualified retirement plan through work, you may not deduct all or some of your IRA contributions unless total income is no more than moderate.  In 2012, at least some IRA contributions are not deductible when income exceeds $58,000 for single taxpayers and $92,000 for married people who file jointly, but only $10,000 for married individuals who file separately.

Where an IRA contribution will not be deductible, savings can be increased by employing a Roth rather than traditional IRA.  Earnings on Roth IRAs aren’t taxable.  However, you can contribute to a Roth IRA only if your income is within statutory limits.  Different rules apply to conversions of traditional IRAs to Roth IRAs and roll overs of qualified plans to traditional and Roth IRAs.

If you contribute to an IRA more than is allowed, you may be subject to a penalty of 6% for each year the excess contribution stays in the IRA.  However, if you fail to take minimum required distributions from an IRA, a 50% penalty can apply to the amount you should have withdrawn.  Determination of required minimum distributions is complex and since the stakes are so high, it can be worth the cost for professional advice.

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