Whether you're a member of the workforce or retired, taxes are something you're liable for. But if you're not careful about the way you manage certain tax-advantaged accounts, you could wind up on the hook for IRS penalties that cost you more money than you might imagine. Here are a few to steer clear of.
1. Early retirement plan withdrawal penalties
Since the IRS offers a tax break for funding and investing in an IRA or 401(k) plan, it expects you to keep that money locked up until retirement. As such, if you remove funds from either account prior to the age of 59 1/2, you'll face an early withdrawal penalty equal to 10% of the sum you remove.
There are, however, a few exceptions to this rule. You are allowed to remove funds from an IRA prior to age 59 1/2 to buy a first-time home or pay for college. Meanwhile, you can take withdrawals from your 401(k) if you're at least 55 years old, you separate from the company sponsoring your 401(k), and you don't own 5% or more of that company. There are a few other exceptions, too, but for the most part, if you want to avoid early withdrawal penalties, leave your IRA or 401(k) alone until at least age 59 1/2.
2. RMD penalties
Unless you're housing your retirement savings in a Roth IRA, you're required to start removing a portion of your account balance each year once you turn 72. (Note that this age used to be 70 1/2, but the SECURE Act pushed it back.) That sum is known as your required minimum distribution, or RMD, and it's calculated based on your account balance and life expectancy.
The purpose of RMDs is to ensure that you eventually draw down your entire savings balance in your lifetime rather than leave your IRA or 401(k) to your heirs. And if you don't take your RMD, the IRS will impose a 50% penalty on whatever sum you fail to remove. For example, if your RMD one year is $5,000 and you don't take it at all, you'll lose $2,500, just that like.
Your first RMD is due April 1 following the year you turn 72. All subsequent RMDs are due by the close of each calendar year.
3. Health savings account penalties
Health savings accounts, or HSAs, offer a great opportunity to set money aside for near- and long-term healthcare expenses. The money you put into your HSA goes in tax-free, and any funds you don't use immediately can be invested for added growth and then withdrawn, tax-free, at any time to cover qualified medical expenses. If you remove funds from your HSA before age 65 for nonmedical purposes, however, you'll be assessed a 20% penalty on the amount you withdraw.
Now, once you turn 65, the rules change. At that point, you can remove HSA funds for any purpose and avoid that 20% penalty. But in that case, your withdrawal won't be tax-free.
Save your money
It's easy to lose money to IRS penalties, but now that you're aware of the above rules, you can take steps to ensure that that doesn't happen. And the better you're able to avoid costly penalties, the more of your hard-earned money you'll get to keep for yourself.