Who Pays For a Mistake in Your IRA? | Ed Slott and Company, LLC

Who Pays For a Mistake in Your IRA?

By Beverly DeVeny, Chief IRA Analyst
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You took a distribution from your employer plan or another IRA and the receiving company put it in the wrong account. Your IRA company did not process your 72(t) distribution in the correct amount. An advisor/salesman told you that the company offering a “great” investment could hold it as an IRA. Someone at the bank told you that you could do a rollover in 90 days, or that you could roll over more than one IRA distribution in a year. You inherited an IRA and someone told you to cash it out and then roll it over or move it to an IRA in your own name.

All of these are common mistakes. Our retirement funds are governed by many rules that dictate what can and cannot be done with those funds. And, by the way, these rules for the most part come from Congress. IRS is responsible only for the procedures to enforce those rules.

What happens when someone else makes a mistake with your IRA or employer plan funds or gives you advice that is just plain wrong? Usually, there is a penalty. The penalties are set by Congress and are paid by you, the retirement plan owner, even if an advisor steals money from your IRA.

Why are these penalties owed by you, the innocent IRA owner? Because the “I” in IRA stands for “individual.” The tax code is structured so that you are totally, 100%, responsible for the correct operation of your IRA. All distributions from your IRA must be made using your Social Security number, thus any taxes, penalties or interest are owed by you. Employer plan participants may not be at as much risk, but they will be responsible for any amounts distributed to them or that are deemed to be distributed to them.

Penalties for retirement plans range from a 6% additional tax (penalty) to a complete distribution of an IRA or retirement plan account and the subsequent income tax due on the distribution. Penalties are reported by you on IRS Form 5329. When that form is not filed, which is what happens when you are unaware of an error that creates a penalty, the statute of limitations does not start to run on the penalty. When you finally become aware of the problem, not only do you owe the penalty, but you also could potentially owe failure to file penalties or accuracy related penalties, and interest on some or all of those items. IRS does not have the authority to waive most of those penalties.

For mistakes that are fixable, there is usually a process that must be followed to undo the error. A common error is doing a Roth conversion before taking your required minimum distribution (RMD) for the year. The RMD is not eligible to be converted to a Roth IRA. This mistake cannot be fixed by simply removing the RMD amount from the Roth IRA. It has become an excess contribution in the Roth IRA and must be removed by following the rules for correcting an excess contribution.

It is critically important that you:

  1. fully understand the investments that are recommended for your IRA
  2. engage in no self-dealing between your IRA and yourself
  3. follow-up on all transfers or deposits between your IRA and yourself
  4. understand the basic rules that govern IRAs – IRS Publication 590 is a good place to start.

And that is the best way to avoid most errors made in retirement accounts.

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