Traditional Individual Retirement Accounts (IRAs) were first introduced in 1974 as simple savings plans for workers who did not have pensions. But over time, they have evolved into one of the more complicated areas of the US Tax Code. There are multiple varieties of IRAs—Inherited, Roth, Self-directed, SEP, SIMPLE, Spousal—and each has its own rules for contributions, distributions, conversions and taxation. Not only is it easy to make a mistake, but the penalties can be severe.
The good news, says retirement expert Ed Slott, CPA, is that some of the most common IRA mistakes can be fixed or the damage can be ameliorated—as long as you know the specific corrective actions.
Here are five IRA mistakes and the best fixes…
Mistake: You withdraw from several IRAs to roll the money into one consolidated IRA. Many people use this strategy to avoid managing multiple accounts and to save money on annual brokerage fees. It’s called an “indirect” rollover, and the IRS allows you to do one within any 12-month period either from IRA to IRA…or Roth IRA to Roth IRA without tax consequences. Once you remove the money from your IRA, you have 60 days to deposit it in another IRA. Otherwise, the withdrawn funds are deemed taxable income. Problem: IRA owners mistakenly think the once-a-year rule applies to each account separately…not to all your IRAs. Example: You remove $5,000 from one IRA and $5,000 from another to put $10,000 in a consolidated IRA. The IRS considers the second $5,000 a taxable distribution. If you are under 59½, taking the second distribution could even trigger a 10% early-withdrawal penalty.
What to do: If you have already taken more than one IRA distribution, roll over the largest one into the consolidated IRA as intended. You still will have to pay tax on the second distribution, so consider removing it from the consolidated IRA and putting it in a Roth IRA. This only works if you can do it within the 60 days—then it qualifies as a valid Roth conversion, and conversions do not count against the one-rollover-per-year rule.
If a distribution that is not eligible for rollover is deposited to an IRA, it is considered an excess contribution and must be corrected or penalties will apply. To avoid penalties, the excess amount must be removed by the extended filing deadline (normally October 15) of the year following the year of the contribution. If the account has changed in value in the period after you made the excess contribution, the amount to be withdrawn actually may be higher than the amount you contributed…or it may be lower. The IRS uses a formula to determine this additional amount, known as net income attributable (NIA). Typically, your IRA custodian will calculate your NIA, but a worksheet with the formula can be found in IRS Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs).
Better: Avoid this entire snafu by making only “direct” rollovers—request that your IRA custodian electronically transfer the money that is to be moved from one IRA to another. Transfers like this are not subject to the once-per-year rule. You can move retirement money between similar IRAs as many times as you like during the same year.
Mistake: You forget to take an RMD from your IRA or you take the incorrect amount. After you reach age 73, the IRS requires you to withdraw an annual RMD from your non-Roth IRAs and pay taxes on the distribution. The RMD is calculated based on the total balance of all your IRAs, including SEP and SIMPLE IRAs, but the overall RMD can be withdrawn from one or any combination of your IRAs. The current extra tax—called an excise tax—for not doing so is now 25% of the amount not taken.
What to do: You can reduce the extra tax for a missed RMD to 10%—instead of 25%—if you catch your error…withdraw the proper amount…and pay taxes on it by the end of the second calendar year following the year for which the RMD was missed. Example: If you don’t take your 2024 RMD by December 31, 2024, you have until December 31, 2026, to qualify for the reduced penalty. Report the missed distribution on IRS Form 5329, Additional Taxes on Qualified Plans. You may qualify for a waiver of the entire penalty if you include a statement with Form 5329 providing a reasonable, good-faith explanation for missing the RMD. Examples: You were hospitalized or suffered a death in the family and were unable to make timely financial moves…you were confused by the regulations and withdrew part of your RMD from your IRA and from your spouse’s…you received incorrect advice from your CPA. You should have proof of these reasons available in case you are questioned.
Mistake: You contribute to a Roth IRA for a child or grandchild who has little or no earned income. In 2024, you can put up to $7,000 a year in a Roth for someone as long as that person reports that amount of earned income from formal employment or self-employment. Example: If your granddaughter earned $2,000 walking dogs, you could contribute up to $2,000 to a Roth IRA in her name. Problem: If you make contributions to the Roth in excess of the amount she earned, it is considered an excess contribution, and your grandchild will have to pay a 6% penalty on the excess amount for every year that money remains in the IRA and is not corrected.
What to do: To avoid the 6% excess contribution penalty, ask the child’s Roth IRA custodian to remove the excess amount and the NIA by October 15 of the following year (for a 2024 contribution, the deadline is October 15, 2025).
If you make excessive contributions to your own Roth IRA: This may happen because your income for the year is too high to qualify for a full Roth IRA contribution (see eligibility limits for 2024 at https://www.irs.gov/pub/irs-drop/n-23-75.pdf ). To correct the error, you can remove the excess contribution before the October 15 deadline, as in the above example…or you can ask your custodian to “recharacterize” the excess amount, switching it from a Roth IRA contribution to a traditional IRA contribution. (Remember—the total amount you can contribute to all your traditional and Roth IRAs for 2024 is $7,000…or $8,000 if you are age 50 or older). Other caveats for correcting excess contributions in your Roth IRA: You must correct the excess from the same IRA that triggered the excess contribution. If you have multiple IRAs, you can’t cherry-pick the IRA you want to “fix.” Also, if you made multiple contributions to an IRA, the last one is considered the excess contribution. Corrections must be reported in the year of the withdrawal on IRS Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, Etc.
Mistake: You roll over an RMD into a Roth IRA. People fall into this trap because they reason that they already are paying the tax on the RMD, so why not convert it to a Roth IRA? Sorry…under federal tax law, a conversion is actually considered a rollover and RMDs can never be rolled over. When they are, they become excess IRA contributions subject to the 6% penalty (see above). Once your RMD for the year is satisfied, you have the option of converting distributions from your IRA into a Roth IRA.
What to do: To avoid a penalty, you have until October 15 of the year after the year of the excess contribution to make the correction. In other words, if you rolled over your RMD in 2024, that amount must be withdrawn from the Roth IRA along with the NIA by October 15, 2025. No special tax forms are required, and any earnings withdrawn are taxable.
Mistake: Not making an IRA contribution because you’ve already filed your tax returns for the year.
What to do: For tax year 2024, you have until April 15, 2025, to make a traditional or Roth IRA contribution even if you already sent your taxes to the IRS earlier in 2025. So, if you don’t have the money to make a 2024 IRA contribution, file your taxes anyway and claim a deduction (for traditional IRAs). If the timing works out, you can fund your IRA contribution with your tax refund. Use IRS Form 8888, Allocation of Refund (Including Savings Bond Purchases), to direct part or all of your refund to apply it as an IRA contribution for the prior year.
