Penalty Taxes on Retirement Plans

It seems that no matter what you do with your retirement money, there is a tax penalty lurking around a corner. Retirement plans have limits to the amount of money you can contribute to them annually. For individual retirement accounts, this amount is a relatively tiny $5,000 for 2008. If you are age 50 or above before the close of the taxable year, you may contribute an additional $1,000. If you contribute more than you are allowed to, you will be assessed a 6 percent excise tax on the excess amount and its earnings. If you try to withdraw funds from your retirement account before you turn 59½, you may be subject to an additional 10 percent penalty.

You must begin receiving distributions from most retirement plans by April 1 of the year after you turn 70½. However, waiting till the year after you turn 70½ to begin taking distributions could result in extra taxes for that year because two distributions will be required in the same year—one for the year in which you turned 70½ and one for the current year. If you take out too little, you will be hit with a 50 percent penalty on the difference between the required minimum distribution and the amount you actually withdrew.

You must withdraw your minimum distribution by December 31 in any year distributions are required.

As you can see, you can save a considerable amount of money if you know and follow the rules for avoiding tax penalties.

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