3 Financial Penalties Every Retiree Should Avoid

By Matt Bell on 22 March 2018 0 comments

Managing money effectively can be challenging enough, but paying unnecessary financial fines only makes it tougher — especially in retirement. Here are three hefty penalties many older people may face, and how to avoid them.

1. Failing to take RMDs

If you are age 70½ or older, have money in a tax-deferred retirement account, and fail to take your required minimum distributions (RMDs), you will owe a penalty equal to half the required-but-not-taken amount. You'll also have to catch up on the amount you were supposed to take and pay tax on that.

The potential penalty pertains to traditional IRAs and 401(k)s — any retirement account that enabled you to make tax-deductible contributions and defer taxes on investment gains. It does not pertain to Roth accounts.

You see, Uncle Sam wants his money, and age 70½ is as long as he's willing to wait. Even if you don't need the money, you have to start drawing it out of your account(s) and paying taxes on it or face the penalty.

To determine the amount of your RMD for a particular year, take the account balance at the end of the prior year and divide it by the distribution period from the IRS's Uniform Lifetime Table found in these IRS work sheets.

For the year you turn 70½, your RMD must be taken by April 1 of the following year. For all subsequent years, it must be taken by the end of the year. If you have multiple accounts, you must calculate your RMD for each one. For IRAs, the total distribution amount can be taken from just one of the accounts or spread out across all of them, and it can be taken as a lump sum or little by little throughout the year. RMDs from employer-sponsored retirement accounts or inherited IRAs must be taken from their respective accounts.

2. Claiming Social Security too early

If you claim Social Security benefits when you are first eligible at age 62, you will lock yourself in to the lowest possible monthly payments. For those born in 1960 or later, it will be about 30 percent less than if you wait until your full retirement age of 67.

The Social Security Administration's full retirement age chart has the details. Even better, check the actual benefit amounts you'll be eligible for at different ages by creating your own account on the SSA's site.

Some argue that by collecting even a reduced benefit beginning at age 62, that five-year head start is more beneficial than waiting. And it's true that there are some people for whom it may make sense to claim as early as possible. However, with longer life spans, waiting at least until full retirement age — and arguably, even waiting until the maximum age of 70 — will prove most beneficial for most people.

Plus, consider a married couple's situation in which the man is the higher earner. Because women tend to live longer than men, and because widows are eligible to replace their monthly benefit with their husband's upon his death, that's one more reason why a higher-earning husband may want to wait until he's eligible for his highest monthly benefit. (See also: 3 Reasons to Claim Social Security Before Your Retirement Age)

3. Missing the Medicare sign-up deadline

Medicare eligibility begins at age 65. If you claim Social Security benefits at least four months before your 65th birthday, you'll be automatically enrolled in Medicare at the appropriate time. However, if you hold off on Social Security until you're older than 65 but you want Medicare coverage, you'll have to sign-up for it within a seven-month window that begins three months before your 65th birthday month. Otherwise, you'll face two possible penalties — one for Medicare Part A (hospital insurance) and one for Part B (medical insurance).

Most people qualify for premium-free Part A coverage based on how much they or their spouse contributed to Medicare during their careers. However, if you don't qualify for free Part A coverage and don't sign up on time, opting for it later will cost you in the form of premiums that are 10 percent more expensive than they would have been otherwise.

Those higher premiums will be in effect for twice the number of years that you've been eligible for coverage. In other words, if you sign up at age 67 (two years past the age when you were first eligible), you'll owe the higher premiums for four years. Bottom line on Part A? Most people should sign up when they are first eligible.

The penalty for missing the sign-up window for Part B is even more significant — 10 percent higher premiums for as long as you have coverage. Plus, your earliest opportunity to sign up will be the next January-through-March period, with the policy going into effect on July 1, so you may experience a coverage gap.

Of course, a prime reason why you might want to opt out of Medicare Part B is that you're still working, have health insurance, and don't want to pay the additional premium.

According to Medicare, if your employer has less than 20 employees, you should sign up for Medicare Parts A and B when you are first eligible. It will become your primary health insurance, with any other coverage you have only paying expenses not covered by Medicare.

If your employer has 20 or more employees and you are covered by a group insurance plan, you don't have to sign up for Medicare Part B (if you do, it will become your secondary insurance). However, when you leave that employer, you'll have to sign up within eight months or face the penalty mentioned earlier. (See also: How to Make Sense of the Different Parts of Medicare)

Clearly, as you get older, certain birthdays aren't just causes for celebration. They're reminders to make careful decisions about your tax-deferred retirement accounts, Social Security, and Medicare.

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3 Financial Penalties Every Retiree Should Avoid

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