What Are the Penalties of Traditional IRAs?
Traditional IRAs allow you to save for retirement through tax-deferred investment growth. Additionally, those who meet income guidelines are able to deduct traditional IRA contributions from income. These tax benefits come with regulations maintained by the Internal Revenue Service. Mistakes are assessed tax penalties; understanding regulations can prevent unwanted tax issues.
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Early Distribution Penalty
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Taking liquidations before retirement yields a 10 percent penalty imposed by the IRS. The designated age for normal IRA distributions is 59 1/2. Normal distributions are added to income exclusively. Early distributions get the penalty and are added to income. There are waivers to this penalty. Distributions to someone permanently disabled, paying for college tuition for yourself or a lineal heir and using up to $10,000 for a first home for yourself or a lineal heir are exempt from the 10 percent but are still added to income.
Excess Contribution Penalty
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Not everyone is eligible to contribute a fully deductible traditional IRA contribution. Income phaseout limits allow those falling under the floor to make fully deductible contributions. Those in the phaseout range can make partially deductible contributions with those over the range still being able to make the full contribution, but not able to deduct any of it. The phaseout range for single filers covered by an employer plan is $56,000 to $66,000 with no limit if not covered by a plan. Married couples with at least one spouse covered by an employer plan have a phaseout range of $90,000 to $110,000 with the range jumping to $169,000 to $179,000 if not covered by a plan. Contributing more than the 2011 limit of $5,000 or deducting more than you are allowed to results in a 6 percent tax penalty that accumulates annually until the excess is removed. Avoiding the penalty means taking the excess before the filing deadline for tax returns.
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Required Minimum Distribution Penalty
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When a traditional IRA owner reaches age 70 1/2, a Required Minimum Distribution must be taken annually. The first RMD must be taken by April 1 in the year following the IRA owner turning 70 1/2. Each year, thereafter, the RMD must be taken by Dec. 31 based on the previous year's Dec. 31 IRA value. A 50 percent IRS penalty is assessed on the money that should have been taken out that wasn't.
Prohibited Transactions
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Prohibited transactions are not limited to the IRA owner. If the spouse, lineal descendant or beneficiary engage in prohibited transaction at any time during the year, the IRA stops receiving IRA status. In fact, it is considered 100 percent distributed as of the first day of the calendar year the prohibited transaction was done. Activities prohibited include borrowing from or against the IRA, selling personal property into the IRA, taking unreasonable compensation for managing the IRA or its assets or using IRA assets for personal use. Non-owner or beneficiaries managing IRAs who conduct prohibited transaction are liable for 15 percent in penalties initially with 100 percent in penalties assessed if the issue is not corrected.
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