Higher Taxes in 2013 for Grandma and Grandpa.

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A huge thank you to retirement plan expert Brett Goldstein for this important article.

The IRS wants you to use IRAs to save money for retirement.  Why?  When you retire they get to tax your money when you withdraw it.  The IRS entices you to use IRAs by giving you a tax break.

Unlike a regular stock or mutual fund account, you don’t pay taxes on the gains or dividends every year.  The money in your IRA grows tax-deferred, which means you only pay taxes when you withdraw your money at retirement. The IRS also gives you a tax break when you make a contribution to an IRA.

They know that these tax breaks will get people to save money in their IRAs.  They are willing to give up a few tax breaks so they can tax your large nest egg.  So far it has worked.  According to the Investment Company Institute, IRAs held $5 trillion at the end of June 2012.

To make sure that the IRS gets their fair share of the $5 trillion in retirement money, they have created the Required Minimum Distribution (RMD) rules.  The RMD rules say that you have to start withdrawing a minimum amount from your IRA by the time you turn 70 ½. The first RMD must be withdrawn by April 1 of the calendar year after your 70 ½ birthday.  All other distributions must be done before December 31st

The RMD rules are complex and trying to understand these rules is difficult, even for your CPA and financial planner.  You’ve heard the expression, “its not rocket science.”  RMD rules are not like rocket science; they actually might be more complex than rocket science.   However breaking these rules, will cause you to face fines and penalties that can make your retirement nest egg vanish quickly.

Unfortunately these rules are so complex that most of America was not following them.

In a study by the IRS, they identified 471,383 individuals who were supposed to take their RMD in 2005, but failed to do so.  With so many people not following the rules, the IRS was not equipped to impose penalties on so many people.  The IRS estimates that in 2006 and 2007 they lost $174 million in revenue by not being able to impose penalties on people who did not take their RMD.  That is all about to change in 2013 as the IRS has now developed a system to catch people who have not taken their RMD.

The financial institution holding your IRA is required to file Form 5498, which provides the IRS with how much money you have in your IRA as of December 31. Form 5498 also informs the IRS of what your RMD was. The financial institution holding your IRA is also required to provide the IRS with Form 1099-R, which tells the IRS how much money you withdrew from your IRA.

Essentially the Form 5498 tells the IRS how much you have in your IRA and the minimum amount of money you were suppose to withdraw.  The IRS computers have been programmed to look at the 1099-R to see if it matches up with the Form 5498.  If the 1099-R and the Form 5498 don’t match up, then the RMD was not properly calculated; and the IRS computers will now be issuing you a letter imposing penalties.

What kind of penalties will the IRS impose?  The IRS may impose a 50% penalty and a 6% penalty.  For example, a person with a $100,000 dies at age 72 and doesn’t take an RMD. The spouse then rolls the $100,000 into their own IRA.

According to the IRS, the required minimum distribution at age 72 is $3,906.25.
By failing to take the RMD of $3,906.25, the IRS can impose a 50% penalty. In addition the IRS can impose a 6% penalty per year on the spouse for having the $3,906.25 in the IRA.  The total penalties on the spouse is $2,187.50, plus over $200 a year for every year the $3,906.25 stays in the spouse’s IRA.

What’s the scariest thing about these letters that the IRS will now be issuing when the Form 5498 and the 1099-R don’t match up?  The scary thing is that there is no statute of limitations on these letters.  That means that the IRS can look back over the last ten years and impose penalties for every year you failed to take a required minimum distribution.

It is not likely that the IRS will look back over the last 10 years to figure out if you have abided by the IRA laws.  Realistically the IRS may only go back 3 years to check to see if you have taken out your RMD.

How do you avoid penalties?  You need to ask the IRS for a waiver of the penalties.  To request a waiver, you must immediately withdraw the missed RMDs plus interest and file Form 5329. The waiver is commonly granted for those with a reasonable excuse.  If you think you haven’t withdrawn all of your RMD, find someone who is knowledgeable in this area.  Don’t work with just any CPA as the Form 5329 is not an easy form to fill out.  If Form 5329 is not filled out correctly, you could face even more penalties.

With the U.S debt over $16 trillion, it isn’t surprising that the IRS is trying to penalize people for not following the IRA laws.  It’s far easier to raise revenue by simply enforcing existing tax laws, than it is to cut spending or increase taxes.

You can find Brett Goldstein at http://www.americaninvestmentplanners.com/Brett-Goldstein.e456176.htm

One Comment

  1. Steve Thompson says:

    Wow – thank you for the timely and important information. Although I’m a way off from being able to withdraw from my IRA, I’ll be extremely diligent of the rules! Thank you!

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