Retirees need to make their savings stretch as long as possible in retirement. Many folks are surprised by the severe effect that taxes can have on their cash flow. However, Kiplinger’s recent article, “4 Costly Government Penalties Retirees Should Avoid,” says that income taxes aren't the only way Uncle Sam can take a bite out of your life savings in retirement or limit your anticipated benefits. Consider these penalties and try to avoid them:
A Lifetime Reduction in Social Security Benefits for Early Claims. Your age when you begin collecting Social Security benefits has a major impact on the amount of money you’ll ultimately get from the program. You must know your full retirement age. For those born in 1960 or later, full retirement age is 67. You can start collecting Social Security when you turn 62, but if you do, you’ll get a permanent reduction. It could be as much as 25% of your benefit, if your full retirement age is 66.
Another penalty for taking Social Security early is when early claimers who are still working forfeit $1 in benefits for every $2 they make over the earnings limit (2017 is $16,920). When you're past full retirement age, the earnings test disappears, and you can make as much money as you want with no impact on benefits. Any benefits that you forfeited because earnings exceed the limits, aren’t gone forever: at full retirement age, the Social Security Administration recalculates your benefits going forward to take into account benefits lost to the test.
Failure to Take Required Minimum Distributions (RMDs). When you turn 70½, you are required to start withdrawing funds—even if you don’t need the money—from your traditional IRA and employer-sponsored retirement plans, like a 401(k). It’s not hard to figure out what you need to withdraw. Find the year-end balance of every traditional IRA you own, then add them together and divide the total by a factor provided by the IRS that's based on your age and life expectancy.
You typically must take your RMDs by December 31. However, first-timers can delay their initial payout until as late as April 1 of the next year. There’s a big penalty if you don't take your required distribution by the deadline. It is equal to 50% of the amount you failed to withdraw. But the IRS frequently waives the penalty for taxpayers with a good excuse, like poor advice from a tax preparer or IRA sponsor, or falling seriously ill right before year-end when you’d planned to make the RMD.
Penalty for Not Signing Up for Medicare at the Right Time. If you already get Social Security benefits, you're automatically enrolled in Medicare. Your Medicare card will be mailed to you three months before your 65th birthday, and your coverage begins the first of the month after you turn age 65. Those not yet getting Social Security benefits must enroll in Medicare. You have a seven-month window to sign up that begins three months before the month you turn 65 and ending three months after your birthday month (the "initial enrollment period"). Sign up before your birthday month to get coverage as early as possible. If you miss your initial enrollment period, you’ll have to pay a late-enrollment penalty of 10% of the Part B premium for every year that you should’ve had coverage. This penalty applies for as long as you receive Medicare benefits. If you have coverage through an employer with 20 or more employees, you don’t have to sign up for Medicare when you turn 65. Your group policy will pay first, with Medicare paying second. Avoid a future penalty and enroll in Part B, within eight months of leaving your job.
The Death Tax. The federal estate tax will impact estates valued at $5.49 million in 2017. The assets left to a surviving spouse aren’t taxable. Along with federal estate taxes for the extremely wealthy, depending on where you live, you might also have state estate taxes for estates valued at only $1 million.
Reference: Kiplinger (July 2017) “4 Costly Government Penalties Retirees Should Avoid”
If you need help planning for retirement, give our office a call for a free consultation, 801-438-7120