Retirement Plan Tax Prep Checklist

Check this by Dec. 31 and don’t forget required minimum distributions

Qualified retirement plans and individual retirement accounts (IRAs) give you the opportunity to save for retirement on a tax-advantaged basis. Earnings on contributions grow tax-deferred—or tax-free for Roth IRAs and Roth 401(k)s. When it comes to tax time, be sure you are up to date with all requirements.

Key Takeaways

  • Qualified plans, such as IRAs, provide tax advantages, such as earnings accumulating on a tax-deferred basis.
  • Qualified plan contributions must be made by a specific deadline. For example, IRA contributions must be made by the tax filing deadline.
  • Your modified adjusted gross income (MAGI) may limit your contributions to an IRA if you or your spouse are covered by a retirement plan at work.
  • Qualified retirement account participants age 72 or older may be required to take required minimum distributions (RMDs) from their qualified plan annually.

Watch the Contribution Deadline

You have until the tax filing deadline to contribute to an IRA or a Roth IRA. You don’t get more time to make IRA contributions, even if you obtain a filing extension for your tax return.

However, if you own a business, you can contribute to a qualified retirement plan up to the extended due date of your return (e.g., Oct. 15, 2021, for a 2020 contribution), as long as the plan was in place on Dec. 31, 2020 (you signed the paperwork by that date). If you didn’t, you could still set up and fund a SEP IRA by the extended due date of your return.

Use Tax Refunds for Contributions

If you’re owed a tax refund, you can apply it toward a contribution to an IRA or a Roth IRA​. This can be for the 2021 tax year if you submit your tax return in time for the IRS to send the funds to your account’s custodian or trustee; be sure to notify your custodian or trustee that you want the funds applied for 2021. Use Form 8888 to tell the IRS where to send your refund. If funds arrive late or you don’t tell the custodian or trustee that you want them used for 2021, then they’ll be applied for 2022.

Fix Excess Contributions

Your modified adjusted gross income (MAGI) may limit or bar contributions to deductible IRAs if you or your spouse participate in a qualified retirement plan (e.g., you have a 401(k) at work) and to Roth IRAs regardless of any other plans. Any excess contributions—amounts higher than you are eligible to make—are subject to a 6% penalty each year until you take corrective action.

The excess contribution penalty can't be more than 6% of the combined value of all your IRAs as of the end of the tax year.

If you already made a contribution for 2021 and discover that your income was too high, don’t delay fixing the problem. For example, if you contributed to a deductible IRA, don’t take the deduction. Withdraw the contribution, plus any earnings, no later than the tax filing deadline.

The taxpayer has until October 15 to remove any excess contributions to avoid penalties and interest. If the taxpayer files a return by the filing deadline and does not withdraw the excess by that date, the taxpayer can still avoid the excise tax if they withdraw the excess (and income on the excess amount) by October 15, 2022.

If you contributed too much to a Roth IRA because of your income, be sure to take corrective action no later than December 31. In this way, you owe the penalty only for the previous tax year and avoid it for future years. For example, you can withdraw the excess contribution plus earnings or instruct your IRA custodian to treat the excess 2021 contribution and earnings as your 2022 contribution. The contribution limit for 2021 and 2022 remains $6,000 ($7,000 if you are 50 or older), so you’ll have to check whether earnings on the account could still put you over the limit and continue to incur a penalty.

Note that you can no longer “recharacterize” your Roth IRA contribution back to a traditional IRA as you could before the Tax Cuts and Jobs Act (TCJA) of 2017.

Take Required Minimum Distributions

Tax deferral doesn’t last forever. Make sure to understand when—and to what extent—you must take required minimum distributions (RMDs). If you fail to take RMDs, you can be subject to a 50% penalty for insufficient distributions.

RMD rules are very complex. Here is some information to get you started.

  • For your own accounts. If are 72 years or older, you must take an annual distribution based on IRS tables, which can be found in IRS Publication 590-B. Use Table II (Joint Life and Last Survivor Expectancy) if you are married, your spouse is more than 10 years younger than you, and they are the only beneficiary of the account; otherwise, use Table III (Uniform Lifetime).
  • For inherited benefits from a qualified retirement plan or an IRA. What you have to do depends on your relationship with the account holder. If you are a surviving spouse, you can opt to roll over the benefits to your own account and treat them as if they were always yours. Thus, if you’re 60 and inherit an IRA from a spouse who died in 2021, a rollover means you can postpone RMDs until you reach age 72. If you’re not a surviving spouse, you generally must take a distribution of the entire balance by the end of the tenth calendar year after the owner’s death.

There are other notable exceptions to the ten-year rule for eligible designated beneficiaries, including an owner's minor child, a disabled or chronically ill beneficiary, and any other beneficiary who is not more than 10 years younger than the original owner.

As a result of the SECURE Act, passed in 2019, the age requirement for RMDs was increased from 70½ years old to 72 years old, for individuals whose 70th birthday is July 1, 2019, or later.

If you failed to take RMDs, you might qualify for relief by showing reasonable cause for your failure. You don’t have to pay the penalty upfront, but you must file Form 5329 with your tax return and attach an explanation for your failure (e.g., you had a severe medical condition or received bad tax advice about how much to take). What’s more, you must show that you took the RMD as soon as you could. Instructions to Form 5329 explain what to do.

Protect Yourself if You Took Distributions Before Age 59½

Even if you weren’t required to take distributions, you may have opted to do so prior to retirement age because you needed the money. The distribution generally is fully taxable (different rules apply to Roth IRAs and nondeductible IRAs). The distribution is reported to you on Form 1099-R. In addition, if you were under age 59½ at the time, you’ll be penalized 10%, unless you qualify for a penalty exception.

Due to the 2020 economic crisis and its negative financial impact on many American families, the rules were modified around early retirement account distributions for the 2020 tax year. The CARES Act allowed qualified individuals to borrow up to $100,000 or 100% of the vested balance in their retirement accounts (whichever is smaller) as long as they were eligible for stimulus distributions. The distribution is taxable, but taxes can be spread over three years instead of being due entirely in 2020.

If a taxpayer pays the funds back to the plan within three years, it will be considered a rollover and non-taxable. The CARES Act also allows the taxpayer to delay payments on any prior outstanding retirement account loans for up to one year.

In normal years, you may avoid the penalty—but not the tax on the distribution—if you qualify for an exception. The acceptable reasons are listed by the IRS. If you want to rely on an exception, get your proof together now. For example, if you are disabled, be sure to have documentation from doctors, or the Social Security Administration, showing you are totally and permanently unable to engage in any substantial gainful activity. If you used the funds to pay qualified higher education costs for yourself, your spouse, or a dependent, have receipts for these costs.

The Bottom Line

The rules for retirement accounts are complicated. For help, talk to your plan administrator or IRA custodian or, even better, your own tax advisor.

Article Sources

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