5 Sneaky Tax Penalties All Retirees Need To Know About

Saving enough money for retirement is challenging. Many retirees end up with only a relatively small pool of money to live on.

In addition, volatile markets and sneaky tax laws can make it even more difficult to keep hold of the modest savings you already have. Something like an accidental misstep could cost you a lot of money in tax penalties.

Here are some of the common penalties to look out for so you can manage your retirement savings wisely and avoid wasting money.

Saving aggressively is a great way to get ahead financially, but contributing beyond the allowed limit to your IRA can blow up in your face.

If you accidentally contribute too much, you could face stiff penalties. The IRS imposes a 6% tax on any excess contributions that remain in the account at the end of the year. That penalty applies every year until the mistake is corrected.

To avoid this unhappy result, withdraw the extra contributions — and any earnings they generated — by the tax return deadline for the year you made the contributions.

In most cases, dipping into retirement funds before age 59½ can be costly. The IRS charges income tax on early withdrawals, along with a 10% penalty. This rule applies to many types of retirement accounts, including 401(k)s and IRAs.

However, some exceptions allow you to avoid this costly penalty. For example, you may use IRA funds to pay for health insurance premiums after a job loss.

Remember, each retirement plan has its own set of exceptions, so consult a financial expert about IRS guidelines.

If you have certain types of retirement accounts — such as a traditional IRA or 401(k) — you must make required minimum distributions (RMDs) from the account after you have reached a certain age.

Previously, withdrawals had to begin by age 72, but new legislation under the Secure 2.0 Act raised the age to 73. An increase to age 75 is set to take effect in 2033.

If you fail to take your RMD or withdraw less than required, you could be hit with an excise tax. The Secure 2.0 Act reduced the excise tax to 25%, and correcting the oversight within two years can lower the tax to 10%.

To avoid the hassle altogether, you could move all funds from traditional accounts into a Roth IRA or Roth 401(K), as the RMD rules do not apply to Roth accounts. For some people, this makes sense. But for others, it might not. So, consult with a tax professional before making this move.

If you diligently contributed to your health savings account (HSA) during your working years, it has hopefully grown to a significant sum and can help you manage health care costs during your retirement years.

But remember, once you enroll in Medicare, you can no longer contribute new money to your HSA. If you continue making contributions, you could wind up paying a 6% excise tax.

To play it safe, many tax experts and financial planners recommend you stop making HSA contributions at least six months before you apply for Medicare.

Many retirees have their HSA contributions on autopilot, so it's easy to inadvertently continue adding new money to the account. Keep an eye on the clock as your Medicare application day approaches.

Individual states impose their own tax rules and penalties for retirees. This can catch retirees off guard, especially if they retire to a new state where they are less familiar with tax laws.

If you move to a new state for retirement, you might consider meeting with a financial advisor or tax professional in the state to make sure you understand the rules and what is required of you.

Even the most diligent retiree can accidentally run afoul of the tax code. So, if you have any concerns, talk to a financial advisor or tax professional to make sure you are correctly following all the federal and state tax rules for retirees.

You have worked hard for a stress-free retirement, and there is no reason to let the government take a bigger whack at your nest egg than is necessary.