This April 1 Retirement Trap Could Cost You a 50% Tax Penalty

Before you go, we thought you'd like these...
Before you go close icon
ACGRC4 Putting money in purse  mar0028; Alan; Marsh; Vertical; Design; Pics; money; finance; business; closeup; close; up; curre
Every American knows about the April 15 deadline for getting your federal income tax return filed. But most aren't aware of an April 1 deadline that could cost up to 50 percent of your money in penalties from the Internal Revenue Service.

Fortunately, this draconian penalty only applies to those who turned age 70½ and have either individual retirement accounts or employer-sponsored retirement plan accounts like 401(k)s.

Required Minimum Distributions and Your Retirement Account

IRAs, 401(k)s and other retirement accounts let you save for retirement on a tax-deferred basis. But lawmakers wanted to impose limits on how long you could take advantage of those tax benefits.

In order to force people to take distributions from the IRAs and 401(k)s -- and therefore pay income tax on the amount they withdrew -- the laws governing retirement accounts require retirees to start taking withdrawals once they turn 70½. The one exception applies to workplace retirement plans: If you still work after 70½ you don't have to take 401(k) or other employer-plan distributions.

The withdrawal amount is based on your age, with the IRS using life expectancy tables to determine how much you have to withdraw. For the 2 million who turned 70½ after July 1 last year, the IRS-calculated life expectancy is 27.4 years, and so the required minimum distribution from your account is 100 percent divided by 27.4 -- or about 3.65 percent of your total retirement-account balance as of Dec. 31, 2012.

%VIRTUAL-article-sponsoredlinks%In most years, retirees have a Dec. 31 deadline to take required minimum distributions. But for your initial required minimum distribution, you get an extension to April 1 of the following year. Miss that deadline, and the IRS imposes a 50 percent penalty on the amount you should have withdrawn.

Unfortunately, many people take full advantage of that extension -- and some don't even realize that the deadline is there. According to figures from Fidelity, 40 percent of those required to take their first required minimum distribution in 2013 hadn't taken the full amount by year-end, and 36 percent of that group hadn't taken any distribution.

It can be hard to keep track of all your financial deadlines, but if you turned 70½ in 2013, the April 1 deadline is one you can't afford to miss.

You can follow Motley Fool contributor Dan Caplinger on Twitter @DanCaplinger or on Google+.
Read Full Story

People are Reading