An individual retirement account (IRA) is a form of retirement plan that provides tax advantages for those individuals who set aside savings for their future retirement. Taxpayers can contribute a certain amount each year and reduce their annual taxable incomes by the amount contributed. Further, until the individual IRA owner reaches the age of 70 and a half, the actual contributions to the IRA plus any earned interest grow tax free.
Unless an exception applies, money can typically be withdrawn penalty free as taxable income from an IRA once the owner reaches age 59 and a half. Further, owners must begin taking distributions of at least the calculated minimum amounts by April 1 of the year after reaching the age 70 and a half. The amount that must be withdrawn (the minimum required distribution) is calculated based on a factor taken from the appropriate IRS table and is based on the life expectancy of the owner and possibly his or her spouse as beneficiary, if applicable. At the death of the owner, distributions must continue and if there is a designated beneficiary, distributions can be based on the life expectancy of the beneficiary.
Now is an opportune time for all IRA owners to make sure that they have been complying with tax rules. The Internal Revenue Service (IRS) is going to start cracking down on individual retirement accounts in an effort to collect penalties from taxpayers who do not follow rules regarding maximum contributions and minimum distributions. According to an article in the Wall Street Journal, the crackdown is part of an attempt to collect millions of dollars in previously uncollected penalties.
Individuals are only allowed to contribute a certain amount to regular and Roth IRAs each year. For 2012, one can contribute $5,000 plus an addition $1,000 if over age 50. If an individual contributes more than the allowable amount, he/she may be subject to a penalty of six percent of the excess amount. In addition, if an IRA owner, after having reached age 70 and a half, does not take the required minimum distribution, he/she can be subject to a 50 percent penalty on the amount that should have been withdrawn. The same penalty applies to IRAs that are inherited from another individual. There is no statute of limitations on the penalties, so if errors are made over subsequent years, the penalties can add up quickly.
It is unclear how the IRS will step up enforcement of the penalties. The IRS will report to the Treasury Department in the very near future on its strategies, which could include more paperwork and audits. According to the Wall Street Journal, in 2006 and 2007, the IRS failed to collect $286 million in penalties for missed withdrawals and contributions.
Individuals and financial planners need to look over their IRAs to make sure contributions and withdrawals have been made properly. If any errors are found, they should be corrected immediately because delaying further only increases penalty and interest charges. This should be done in the context of a review of your entire estate plan by an estate planning attorney and a financial advisor.
Ronald Fatoullah & Associates, a law firm concentrating in elder law, estate planning, Medicaid eligibility, special needs, trusts, guardianships, & probate. Ronald Fatoullah is a leading expert in the fields of elder law & estate planning and is the founder and managing attorney of the firm. He is certified as an elder law attorney by the National Elder Law Foundation, and he is the current Legal Committee Chair of the Long Island Alzheimer’s Association. The firm’s offices are conveniently located in: Queens, Long Island, Manhattan & Brooklyn and can be reached at: 1-877-Elder Law or 1-877-Estates. This article was written with the assistance of Debby Rosenfeld, Esq., a senior staff attorney with the firm.