Archive for the ‘RMD’ Tag
Back to Basics Part XXI – Form 5329 – Penalties on Retirement Accounts
Filed under: Back to Basics | Tags: 25%, 401(k), 457, 50%, 529 plan, 59.5, 70.5, Coverdell ESA, Early Distribution, Excess Contribution, Form 5329, HSA, IRA, MSA, nonqualified, penalty, Qualified Plan, Required Minimum Distribution, RMD, Roth-IRA, SEP-IRA, SIMPLE IRA, ten percent
Leave a comment Originally published in the Cedar Street Times
August 21, 2015
The official name for Form 5329 is “Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.” In other words, “penalties on incorrect contributions to or withdrawals out of retirement accounts, education accounts, and medical accounts.”
Most people are familiar with the fact that retirement accounts such as 401(k)s, 457 plans, IRAs, Roth IRAs, SIMPLE IRAs, SEP IRAs, etc. have limits on the amount of money you can contribute each year. They also limit your ability to withdraw money from those accounts until you are generally 59.5 years old, or meet one of a handful of limited exceptions.
Most people are also familiar with fact that you MUST begin taking distributions by the time you reach 70.5 years old (with a few exceptions such as for Roth IRAs, certain employees that have not yet retired from their job, or non-spouse inherited IRAs). You can delay the distribution in the year you turn 70.5 until April 1st of the following year, but if you do that, then you have to take two distributions that year. IRS instructions are often very poorly worded on this particular matter, and often people misunderstand this important point.
Education savings accounts such as 529 plans or Coverdell ESAs as well as tax favored medical spending accounts such as HSAs and Archer MSAs also have annual contribution limits. In addition, you must use the funds for qualified education or medical expenses, respectively.
If you fail to follow the rules, either by accident or out of necessity, you will generally incur penalties, which are calculated using Form 5329 for most of these infractions.
So, how much are the penalties? If you over-contribute to a retirement plan, education account, or medical spending account there is a six percent penalty on excess contributions if you do not withdraw the excess contribution (plus any related investment earnings) within six months of the original due date of the return, excluding extensions (so by October 15 for almost everybody). Any earnings generated by the over-contribution will be treated as distributions of cash to you in the tax year the correcting withdrawal actually occurs. The rules governing distributions (discussed later) will apply and you may be subject to penalties on that portion. The custodian of the account will calculate the related earnings that need to be pulled out of the account when you inform them of the need to withdraw funds.
If you over-contribute for multiple years in a row before realizing it, the penalty compounds. So you would file a Form 5329 for each of the past years (no 1040X needed) and pay six percent on the excess contributions for the year of the 5329 you are filing, plus any prior excess contributions that still had not been taken out. In other words, you pay six percent every year on the excess contribution until you take it out. Interest would also be assessed on top of the penalties.
If you fail to take a Required Minimum Distribution (RMD), the penalty is 50 percent of the amount that was supposed to be taken out, but was not. Unlike the six percent over-contribution penalty that applies every year until you take the funds out, the 50 percent penalty only applies once. But you would need to withdraw the funds and file a 5329 for each past year you failed to take an RMD. Interest would also be assessed on top of the penalties. Fortunately, the IRS has been pretty lenient with the steep 50 percent penalty, and you can often get them to waive the penalty for reasonable cause once you withdraw the money.
Early distributions for all retirement accounts that do not qualify for an exception are subject to a ten percent penalty, (plus inclusion as taxable income for the portion related to original contributions for which you received a tax deduction as well as on any earnings generated while in the account). SIMPLE IRAs have a special rule that increases the penalty to 25 percent if the date of your first contribution to the SIMPLE IRA was less than two years ago.
Distributions from education savings accounts for nonqualified purposes are subject to a ten percent penalty.
Distributions from medical spending accounts that are not used for qualified purposes are generally subject to a 20 percent penalty. These 20 percent penalties, however, are calculated on different forms (8889 for HSAs and 8853 for MSAs). With HSAs when you reach 65, you can use the money for whatever purpose you want, without penalty. You can also rollover an MSA into an HSA.
Regarding the Form 5329 itself, the first two parts deal with distribution penalties for retirement accounts and education accounts (health account distribution penalties are calculated on other forms). The third through seventh parts deal with excess contribution penalties for each different type of account. The final section, part VIII, deals with penalties on RMDs not distributed.
If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Health Savings Account – Your Tax Friend
Filed under: Healthcare Costs | Tags: 213(d), beneficiary, California, custodian, estate, family plan, Flexible Spending Arrangement, FSA, HDHP, health savings account, healthcare, high deductible health plan, HSA, individual plan, itemized deductions, Medicare, nonqualified expenses, ObamaCare, out-of-pocket, qualified medical expenses, RMD, spouse
Leave a comment Originally published in the Cedar Street Times
May 17, 2013
Perhaps you remember a time when you thought you would get a nice fat tax deduction because you spent thousands of dollars on health care costs that insurance did not cover, only to realize you got nothing out of the deal? The cause that lead to this depressing realization was either because you did not meet the threshold for medical expenses, based on a percentage of your adjusted gross income, or even if you did, you still did not have enough itemized deductions to get you over the standard deduction.
As of January 1, 2013, that threshold was raised even higher – now 10 percent of your adjusted gross income (7.5% for another three years for people over 65). For most people this would generally mean if you make $100,000, you get no benefit for the first $10,000 of medical expenses.
A health savings account is a fantastic option which basically allows even people taking a standard deduction to effectively get a tax deduction for much, if not all, of their out-of-pocket medical expenses. There is also no “use-it-or-lose-it” clause such as can be found in the less flexible “Flexible Spending Arrangement” (FSA). Qualified medical expenses for HSA purposes used to be a broader definition than medical expenses in IRC section 213(d) used for itemized deductions, but a few years ago it was essentially unified.
Eligibility to open a health savings account is dependent on whether your health plan qualifies as a high deductible health plan (HDHP). For 2013, an individual plan must have a minimum deductible of $1,250, and $2,500 for a family plan, among other requirements. The premiums for high deductible plans are much lower (but shop around!) since you are paying a good chunk of the first-dollar costs – just like car insurance deductibles.
You then open a checking account with a company that provides custodial health savings accounts and contribute money to this account. Any contributions to the account lower your taxable income in the year of contribution, just like contributing to an IRA. Then you in turn use that account to directly pay all your qualified medical expenses (as well as spouse or dependent expenses) with a checkbook or debit card. With the savings created by lower health insurance premiums you should already have some money to contribute to your account. For 2013 you can contribute up to $3,250 for a single plan or $6,450 for a family plan (add a thousand to those figures if you are over 55).
Whatever you do not use stays in your account for the future, and you can keep contributing each year. If you never use it, you can take it out and use it for whatever purpose you want with no penalty after age 65. It would be taxable income, however, if not used for medical purposes. If you use it before age 65 for nonqualified expenses, there is a 20 percent penalty, plus it is taxable income.
Some people even view an HSA as another way to stuff a few more dollars into a “retirement plan,” but without the requirement to have earned income, plus the benefit of not having to take minimum distributions by age 70 1/2. If you are enrolled in Medicare, however, you can no longer contribute. Some custodians also allow you to link the account to an investment firm and then invest the money in stocks, bonds, mutual funds, etc.
If you pass away and your spouse is named as the beneficiary, your spouse steps into your shoes and becomes the new HSA owner. If it passes to your estate, it becomes taxable income included on your final 1040 tax return. If it passes to any other beneficiary, the HSA becomes taxable income to the recipient except for medical expenses paid within one year after death. One other tidbit of information – the State of California does not conform to Federal legislation regarding HSAs, so you receive no deduction for contributing to an HSA account and any income generated by the funds is taxable for California purposes.
Many companies have been switching to these plans over the past five or six years due to the savings in premiums, and many of the companies pass some of the savings back to the employees by contributing to the HSA account.
At this point, it looks like HSAs will still exist under ObamaCare, and could conceivably become even more popular if ObamaCare does not pan out and insurance rates keep rising. HSA plans have been found to lower the consumption of healthcare services since they do place an economic incentive for consumers to find lower cost options since the consumers pay for 100 percent of the care up to the deductible. Plans that shelter the consumer from any cost at all do not provide this incentive.
However long they stay around, HSAs certainly are a great option for many people today.
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Travis H. Long, CPA, Inc. Blog 