3 Tax Penalties That Can Ding Your Retirement Accounts

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Building and living off a nest egg is tough — but you can make the situation even more difficult if you run afoul of some key laws governing retirement accounts.

Make one wrong move, and the long arm of Uncle Sam may soon tap you on the shoulder, demanding a few explanations.

Following are penalties to avoid at all costs when contributing to or withdrawing from retirement accounts.

Excess IRA contribution penalty

Building a large amount of retirement savings is an admirable goal. But contributing too much to an individual retirement account (IRA) can cost you, according to the IRS.

It’s possible to commit this offense by:

  • Contributing an amount of money that exceeds the applicable annual contribution limit for your IRA
  • Improperly rolling over money into an IRA

What happens if you get a little too eager to build a nest egg and make one of these mistakes? The IRS explains:

“Excess contributions are taxed at 6% per year as long as the excess amounts remain in the IRA. The tax can’t be more than 6% of the combined value of all your IRAs as of the end of the tax year.”

The IRS offers a remedy to fix your mistake before any penalties will be applied. The agency says you must withdraw the excess contributions — and any income earned on those contributions — by the due date of your federal income tax return for that year.

For example, if you contributed too much to an IRA for 2020, you have until April 15, 2021, to withdraw the excess and thus avoid a penalty.

Early withdrawal penalty

Taking money out too soon from a retirement account is another potentially costly mistake.

If you pull money from your IRA before the age of 59½, you might be subject to paying income taxes on the money, plus an additional 10% penalty, the IRS says.

The agency notes, though, that there are several circumstances in which you are allowed to take early IRA withdrawals without penalties. For example, if you lose a job, you are allowed to tap your IRA early to pay for health insurance premiums.

The same penalties apply to early withdrawals from retirement plans like 401(k)s, although again, there are exceptions to the rule that allow you to make early withdrawals without penalty.

It’s crucial to note that the exceptions that allow you to make early retirement plan withdrawals without penalty sometimes differ from the exceptions that allow you to make early IRA withdrawals without penalty.

Note: The Coronavirus Aid, Relief, and Economic Security Act (CARES) Act of 2020 created a one-time exception to the early-withdrawal penalty for both retirement plans and IRAs due to the coronavirus pandemic: Generally, coronavirus-related distributions of up to a total of $100,000 that were made in 2020 are exempt.

Missed RMD penalty

Retirement plans are great because they generally allow you to defer paying taxes on your contributions and income gains for decades. Alas, eventually, Uncle Sam is going to demand his share of that cash.

Previously, taxpayers were obligated to take required minimum distributions — also known as RMDs — from most types of retirement accounts beginning the year they turn 70½. But the Secure Act of 2019 bumped up that age to 72.

The consequences of failing to make these mandatory withdrawals still apply, though. Fail to take your RMDs starting the year you turn 72, and you face harsh penalties, says the IRS:

“If you do not take any distributions, or if the distributions are not large enough, you may have to pay a 50% excise tax on the amount not distributed as required.”

It’s important to note that the RMD rules do not apply to Roth IRAs. You can leave money in your Roth IRA indefinitely — although another provision of the Secure Act means your heirs have to be careful if they inherit your Roth IRA. For more, check out “Why Roth Retirement Accounts Are Now Even Better.”

Disclosure: The information you read here is always objective. However, we sometimes receive compensation when you click links within our stories.

Source: moneytalksnews.com

Be Sure to Do This With Your Tax Software

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In recent years, scammers have targeted a growing number of taxpayers. Now, added protections can help guard you from such fraud.

The IRS recently announced that multi-factor authentication will be available on all 2021 online tax preparation products.

With multi-factor authentication, you must provide two pieces of information to access an account or application. The IRS gives an example in which a taxpayer is required to enter a security code sent by text to the taxpayer’s cellphone, in addition to entering their username and password.

This enhanced security feature means that a scammer who has stolen your password can’t necessarily access your account: The scammer also would need the security code.

The IRS says all tax software providers working with the agency have agreed to make multi-factor authentication a standard feature. However, it might not be available on hard-disc products like the tax preparation software sold in stores.

To take advantage of the extra protection, you must first enable it. Check the security section in your online tax product account. There, you can opt in to multi-factor authentication. The IRS notes that the feature may be called by another name, such as “two-factor authentication” or “two-step verification.”

Some tax software programs also offer more information on their websites. For example, TurboTax’s website has a page titled, “How do I enable or disable the two-step verification feature in TurboTax?”

Having a code texted to your phone is not the only way to get this type of security.

Multi-factor authentication apps such as Microsoft Authenticator and Authy are available. These apps generate temporary, single-use security codes that you can use as the second piece of information you must provide when logging into an account.

Other multi-factor authentication options use physical security keys.

The IRS is urging all taxpayers and tax professionals to use multi-factor authentication whenever possible as a way to prevent fraud. According to the IRS:

“Thieves use a variety of scams to download malicious software, such as keystroke logging software. This malware enables them to steal all passwords from a tax pro. Once they have access to the practitioner’s networks and tax software account, they can complete pending taxpayer returns, alter refund information and use the practitioner’s own e-filing and preparer numbers to file fraudulent returns.”

For more on preparing your taxes this season, check out “How to Get Your Taxes Done Absolutely Free.”

Disclosure: The information you read here is always objective. However, we sometimes receive compensation when you click links within our stories.

Source: moneytalksnews.com

Will You Owe Taxes on Last Year’s Stimulus Payments?

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Two stimulus payments have arrived electronically in most Americans’ bank accounts — or as checks or debit cards in the mail — over the past year as Uncle Sam’s way of helping us get through the coronavirus pandemic.

But now, a lot of people are nervous, wondering whether they are going to owe extra taxes for receiving those payments. We don’t say this often about the IRS, but it actually has some good news for taxpayers.

The federal agency offered the following answer last year after the first round of stimulus payments:

“No, the payment is not income and taxpayers will not owe tax on it. The payment will not reduce a taxpayer’s refund or increase the amount they owe when they file their 2020 tax return ….”

Nor will the payment affect your income when determining whether you are eligible for federal assistance or benefits.

Sound too good to be true? Well, if you need extra reassurance, you can find it right in this year’s instructions for filling out the Form 1040 tax return. In those instructions, the IRS flatly states that the stimulus payments — the agency prefers the term “economic impact payments” instead — “are not taxable for federal income tax purposes.”

Why isn’t the money taxable? Because in the government’s eyes, it’s a tax credit. The payments most of us received last year were merely advance payments of that credit, known as the recovery rebate credit.

So, the bottom line is that if you received your full stimulus payments last year, you are good to go. You won’t need to claim the credit on your tax form, and you won’t owe the feds an extra penny.

If you didn’t receive your full stimulus payments, you can claim the recovery rebate credit on your 2020 return to get the remainder of stimulus money that has been earmarked for you. For more details on claiming the credit, check out “5 Changes to Your Federal Tax Return Form in 2021.”

How to get help on your taxes

Looking for a little assistance with taxes this year? Several organizations offer low-cost help. And some offer their services for free.

For example, Money Talks News founder Stacy Johnson recently looked at the free tax prep service from Credit Karma, and offered this take:

“Credit Karma tax prep will work in nearly every situation, not just simple ones. You can itemize and even file business returns. There are situations, however, it can’t accommodate, such as foreign tax credits, multiple state returns and certain types of trusts.”

For more on Stacy’s thoughts, check out “How to Get Your Taxes Done Absolutely Free.”

Other services that offer tax help include:

Disclosure: The information you read here is always objective. However, we sometimes receive compensation when you click links within our stories.

Source: moneytalksnews.com

7 Income Tax Breaks That Retirees Often Overlook

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How does the adage go? With age comes … new ways to save on taxes.

While you can’t stop filing taxes just because you retire, being a retiree often means you can claim some worthwhile tax credits and deductions.

In some cases, these tax breaks are available to both workers and retirees, so the latter often don’t realize they might be eligible. In other cases, these tax breaks are effectively reserved for older taxpayers, meaning taxpayers may not hear about them until later in life.

Following are several examples of federal income tax breaks that retirees often overlook.

1. Bigger standard deduction

For seniors who don’t itemize their tax deductions, a higher standard deduction is a free potential reduction in your tax bill.

Seniors generally get an increase of $1,300 per married person or $1,650 per single person from the usual standard deduction. For the 2020 tax year — meaning the return that’s due in April — the IRS defines “senior” as someone born before Jan. 2, 1956.

For two married seniors, for example, that’s an extra $2,600 they get to subtract from their taxable income — without doing any work or keeping any receipts. What savings that actually translates into will depend on their income, but it means a lower starting figure for Uncle Sam to tax them on.

2. Saver’s credit

What’s better than a tax deduction? A tax credit! A deduction lowers your taxable income, but a credit reduces your tax bill dollar for dollar.

The saver’s credit isn’t specifically for retirees, so they might easily overlook it. But it’s for any eligible taxpayer who is saving money in a retirement account. That means it’s available to retirees who are still able to stash cash in a retirement account — assuming they otherwise qualify for the credit.

So, for as long as you’re contributing to a retirement plan, you should be checking your eligibility for the saver’s credit each year. If you’re eligible, it could reduce your taxes by up to $1,000 — or $2,000 for married taxpayers filing a joint return.

The main eligibility requirement, besides saving money in a retirement account, is having an income below a certain threshold, as we detail in “This Overlooked Retirement Tax Credit Gets Better in 2021.”

3. Health insurance premium deduction

If you are self-employed, you may be able to deduct your premiums for Medicare or other health insurance plans as a business expense. According to the IRS:

“You may be able to deduct the amount you paid for medical and dental insurance and qualified long-term care insurance for yourself, your spouse, and your dependents. … Medicare premiums you voluntarily pay to obtain insurance in your name that is similar to qualifying private health insurance can be used to figure the deduction.”

For example, the Medicare Part B standard monthly premium for 2020 was $144.60 per month — a potential write-off of $1,735.

4. Contributions to traditional IRAs

A federal law known as the Secure Act of 2019 repealed the maximum age for contributing to a traditional individual retirement account (IRA).

So as of the 2020 tax year, retirees who still are bringing in earned income, such as from a part-time job, can save money in this type of account no matter how old they are — and thus write off that contribution on their taxes.

There is no maximum age for contributing to a Roth IRA, either, although contributions to this type of account are deductible on your tax return. Instead, you instead get to withdraw the money tax-free, provided that you otherwise follow the IRS rules for Roth accounts. (With a traditional IRA, withdrawals are considered taxable income.)

To learn more about these two types of accounts, check out “Which Is Better — a Traditional or Roth Retirement Plan?”

5. Spousal contributions to traditional IRAs

While you can contribute to an individual retirement account (IRA) only if you have earned income such as wages, that can be your spouse’s income.

This means a working spouse can help a non-working spouse save money in a retirement account, as we detail in “7 Secret Perks of Individual Retirement Accounts.”

Spousal contributions to a traditional IRA also qualify you for a tax deduction, assuming you meet income and other eligibility requirements.

6. Qualified charitable distribution

Generally, taxpayers have to itemize their deductions — as opposed to claiming the standard deduction — if they want credit for donating to charity. And after the enactment of the federal Tax Cuts and Jobs Act of 2017, standard deductions got bigger, meaning fewer people benefit from itemizing.

Some retirees may effectively be able to get around this, however.

After age 70½, you can transfer money from an IRA to a charity and have the amount count toward your required minimum distribution (RMD) without counting as taxable income for you. The IRS calls it a “qualified charitable distribution.”

This isn’t a true tax credit or deduction but still has the effect of lowering your taxable income and thus possibly your tax bill, because your RMDs would usually otherwise count as taxable income.

Note that while the Secure Act changed the age at which you must begin taking RMDs from 70½ to 72, that change did not apply to qualified charitable distributions. So, they still can be made at age 70½, according to Ed Slott & Co.

7. Charitable write-off without itemizing

For the 2020 and 2021 tax years, there is another type of charitable deduction available to taxpayers who do not itemize their deductions.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020 temporarily changed the federal tax code such that people who claim the standard deduction can write off up to $300 in monetary donations to charity in 2020. So retirees who donated to charities last year now can claim that break on their return.

Then, a separate law enacted in December last year extended and expanded this charitable write-off for 2021, as we report in “2 Charitable Tax Breaks Have Been Extended for 2021.”

Disclosure: The information you read here is always objective. However, we sometimes receive compensation when you click links within our stories.

Source: moneytalksnews.com