One of the main challenges of retirement is managing your income to make sure it lasts. Most sources of retirement income are subject to penalties for failing to follow appropriate rules. There are also penalties for signing up for Medicare late and even for having too much money when you die.
Know the rules to avoid needless financial pain.
Social Security Penalties
You can begin collecting Social Security benefits at the age of 62, but it will cost you more than 25% of the benefit you would have received by waiting until your full retirement age of 66 or 67.
If you wait until age 70 to file, your benefit will be about 76% more than if you started receiving benefits at age 62.
Working While Retired
If you retire between the ages of 62 and your full retirement age, Social Security will reduce your benefit by $1 in benefits for every $2 you make over the earnings limit. In 2017 that limit is $16,920.
Once you reach full retirement age, the penalty no longer applies. At that point, any benefits you lost due to penalties will be returned to you (over time).
Early Withdrawal Penalties
Withdrawing funds from your Traditional IRA before the age of 59½ invokes a 10% penalty in addition to taxes on the amount withdrawn. You can avoid the penalty if you use the money to pay for college, a first home purchase (up to $10,000), significant medical expenses, health insurance after a layoff or expenses associated with a disability.
You can also set up a series of annuity payments from your traditional IRA to avoid incurring the penalty.
Although you can withdraw already-taxed contributions from your Roth IRA at any time, don’t try taking out earnings fewer than five years after you opened your first Roth account. If you do, you will be slapped with income taxes, plus a 10% penalty, on the earnings withdrawal if you are younger than 59½.
If it has been five years since you began contributing and you are at least 59½, there will be no penalty and no taxes on earnings. Other exceptions include buying a first home, being disabled or your death.
Early withdrawal penalties from a 401(k) plan also end at age 59½. If you are under that age, you will pay a 10% penalty in addition to taxes on funds withdrawn, unless you qualify for an exception.
Exceptions include leaving your job at age 55 or older (age 50 for public safety employees), your death, disability, certain medical expenses, annuitizing your account or a withdrawal related to a domestic relations order.
Required Minimum Distribution Penalty
When you reach the age of 70½, you must start withdrawing funds from your Traditional IRA or 401(k) or pay a penalty equal to 50% of the amount you should have taken out.
In many (but not all) cases, your plan administrator will automatically send your RMD to you. Be sure to claim it on your taxes. If not, you will be penalized by the IRS for failing to report income. Note that RMD rules do not apply to Roth IRAs during your lifetime.
Medicare Failure-to-Enroll Penalty
You must enroll in Medicare at the age of 65, even if you are not receiving Social Security. If you fail to enroll within a seven-month window (three months before the month you turn 65 to three months after), you will pay a 10% penalty on your Part B premium for every year you should have had coverage. Medicare Part D also has a penalty if you fail to sign up or have significant gaps in drug coverage.
Exceptions include coverage through an employer. In that case you will have eight months from the time your employer coverage ends to sign up.
Death Tax Penalty for Being Too Wealthy
If your estate is valued at no more than $5.49 million ($10.98 million for couples), federal estate tax will not apply. There’s also no estate tax on assets left to a surviving spouse.
However, some states enforce taxes on estates of $1 million or more. This can include any source of wealth including real estate and life insurance policies (depending on how they are written).
Trusts can help you control the size of your estate. Check with an attorney to see if this would be useful for your family.
Check with an Expert
Be smart. Make sure you know and follow all the rules and deadlines as you approach and then enter retirement.
Finally, since some of these regulations can be complicated, seek guidance from your financial advisor to minimize exposure and help you avoid needless penalties.