It’s smart to use legal ways to cut your taxes and keep more of your hard-earned money. Making contributions to tax-advantaged accounts—such as a workplace retirement plan, an Individual Retirement Arrangement (IRA), or a Health Savings Account (HSA)—are some of the best strategies to save more. They allow you to save for the future and reduce your tax burden at the same time—a winning combination!
But these special accounts can cost you if you don’t follow the often-confusing IRS rules that govern them. One key regulation you should never violate is the annual contribution limit. Putting too much money in any of these accounts is a big no-no, but it’s surprisingly easy to do.
In this post, I’ll review the allowable contribution limits for an HSA, IRA, and 401k, and explain what happens when you over-contribute. You’ll learn how to fix excess contributions and avoid costly penalties. I’ll also tell you whether the most recent tax proposal from House Republicans will affect your future retirement contributions.
What is an HSA?
An HSA is a special tax-exempt account you can set up for the sole purpose of paying medical expenses. But to qualify for one, you must be enrolled in a qualified high-deductible health plan (HDHP) purchased on the healthcare open market or through an employer.
Contributions to an HSA can come from you, someone else, or an employer.
No matter where you get your health insurance, you always own and manage an HSA as an individual. That means you don’t need permission from an employer or the IRS to set one up and it stays with you even if you change jobs or become unemployed.
Contributions to an HSA can come from you, someone else, or an employer. What you put in is deductible on your tax return, even if you don’t itemize deductions. When you take distributions to pay for qualified medical expenses, your original contributions plus any earnings are completely tax-free.
But if you use your HSA money to pay for anything other than qualified medical expenses, the amount withdrawn will be taxed as income, plus be subject to an additional 20% penalty. However, if you reach age 65 and still have money in an HSA, the penalty doesn’t apply. If you spend it on non-qualified expenses, like a trip to Hawaii, it would simply be subject to income tax.
So, an HSA eventually morphs into something that resembles a retirement account. That’s a great reason to max it out each year, even if you don’t expect many medical expenses.
More employers are offering HDHPs to help workers keep premiums as low as possible. They work in your favor when you're in relatively good health and aren't likely to spend the full deductible each year.
So, no matter if you bought a health policy on your own or through work, find out if it qualifies for an HSA. A couple of great places to open your account are Lively and HSA Bank.
Related: How to Save Money on Healthcare with an HSA.
What Are the HSA Contribution Limits?
As I mentioned, there are strict limits on the total amount you can contribute to an HSA each year. Annual HSA limits apply to funds contributed by you, someone else, or your employer.
Annual HSA limits apply to funds contributed by you, someone else, or your employer.
For 2017, if you have a qualifying HDHP for yourself, the contribution limit is $3,400, or with a family plan, you can contribute up to $6,750. Next year the HSA limits go up slightly: For 2018, you can contribute up to $3,450, or up to $6,900 with a family plan.
For any year you make HSA contributions, there’s also a “catch up” policy that allows you to contribute an additional $1,000 when you have either an individual or a family policy, if you’re age 55 or older by year-end.
These total contribution limits apply when you’re covered by a HDHP plan for the full year. If you have coverage for just part of the year, your contribution limit is reduced proportionately.
You can make contributions at any time, even up to the tax filing deadline for the previous tax year. For instance, you can make 2017 HSA contributions until April 17, 2018. But you’re never required to make contributions to an HSA.
What To Do When You Contribute Too Much to an HSA
I mentioned that it’s surprisingly easy to over-contribute to tax-advantaged accounts. You may simply lose track and contribute too much over time. For example, if your HSA limit is $3,400 per year and you put in $300 per month, you’d end up contributing $3,600. The extra $200 must be removed to comply with IRS rules.
It’s also easy to over-contribute to an HSA if your employer makes contributions that are not clearly defined or are variable. Unlike employer matching on a workplace retirement account, which we’ll cover in a moment, employer contributions to your HSA are included in your annual limit. The onus is on you, not your employer, to catch and correct excess contributions.
Unlike employer matching on a workplace retirement account, employer contributions to your HSA are included in your annual limit.
Another situation when your HSA may get too big is if you make a large contribution early in the year, but then lose HSA-eligible insurance. The good news is that even if you become uninsured or switch to a non-qualified health plan, you can still spend your existing HSA balance on qualified medical expenses.
However, after you’re no longer enrolled in an HDHP, you’re not allowed to make additional contributions to an HSA. So, you’d need to remove a proportional amount of excess if you lose eligibility during the year.
If you contribute too much to an HSA and don’t correct it, you’re charged a penalty rate of 6% each year on the excess that remains in your account. But if you catch the mistake before you file taxes (including extensions), you can avoid the penalty by simply withdrawing the excess, plus any investment or interest earnings it made.
However, those earnings would be subject to tax. But if you catch an overage right away, the earnings and tax due will likely be very small.
Figuring the correct amount to withdraw and pay tax on can be somewhat complicated. So always contact the administrator of your HSA to discuss correcting an annual overage. The custodian must file Form 1099-SA showing a distribution of excess contributions and correct your Form 5498-SA, which shows annual HSA contributions.
Another option to correct excess HSA contributions is to apply them to a future year. While rolling over funds to the next year sounds easy, the downside is that you still must pay the 6% penalty on any excess amount that remains in your account.
What Are the IRA Contribution Limits?
Now, let’s discuss the limits and remedies when you contribute too much to retirement accounts, which have similarities to an HSA.
An IRA is a tax-advantaged retirement account for individuals provided by many financial institutions. It’s one of my favorite savings vehicles because it offers so much flexibility and tax savings. It comes with annual contribution limits and allows you to correct any excess by your tax filing deadline.
For 2017, you can contribute up to $5,500 to a traditional IRA, a Roth IRA, or a combination of both. If you’re age 50 or older you can contribute an additional $1,000.
While you can contribute to a traditional IRA, no matter how much you earn, there are annual income limits to qualify for a Roth IRA. For 2017, single taxpayers who earn over $133,000 and joint filers who earn over $196,000 are ineligible to contribute.
The Roth IRA income threshold is higher for 2018: single taxpayers with earnings over $135,000 and joint filers who make over $199,000 won’t be able to make contributions.
These income caps make it easy to accidentally over-contribute to a Roth IRA if your income turns out to be more than you expected. Even if you’re not a high earner, if you contribute $500 a month to either a traditional or a Roth IRA, that’s $6,000 for the year, which would be an excess of $500 that you’d need to correct.
Related: 10 IRA Facts Everyone Should Know
What To Do When You Contribute Too Much to an IRA
It’s important to try to prevent excess IRA contributions from occurring in the first place, but it’s even more important to get them corrected on time. Just like with an HSA, if you don’t repair an over-contribution, it’s subject to a 6% penalty each year that it remains in an IRA.
It’s important to try to prevent excess IRA contributions from occurring in the first place, but it’s even more important to get them corrected on time.
Here are 3 options to fix your IRA when you contribute too much:
1. Make a withdrawal before taxes are due.
Contact your IRA custodian and ask for help withdrawing excess contributions, including any income they earned, before your tax filing due date. The excess will be considered as never having been contributed. However, income earned on excess contributions is subject to taxes, plus an additional 10% early withdrawal penalty, if you’re younger than age 59½.
For example, let’s say you’re 40 years old and make an excess IRA contribution of $500 this year, which earns $50 in investment income. If you withdraw $550 before April 17, 2018, your tax filing due date, you won’t have to pay an excess penalty of 6%.
However, you must include the $50 of earnings in your gross income for the 2017 tax year. And because you’re under age 59½, you must pay an additional 10% early withdrawal penalty on your earnings, which comes to $5. Your custodian will send you Form 1099-R showing what amount of earnings are taxable when you make an IRA correction.
2. Make a withdrawal within 6 months after taxes are due.
If you file taxes, but later realize that you contributed too much to an IRA, you can get an extra six months to correct it. Simply follow the previous option and file an amended tax return by October 15 using Form 1040X.
Also note that you can extend your tax due date in any year, if you file Form 4868.
3. Apply the excess to the following year.
You can ask your IRA custodian to apply over-contributions to the following year, if they don’t exceed the maximum allowable limit for that year. But the 6% penalty still applies until the excess is corrected.
Free Resource: Download the Retirement Account Comparison Chart PDF for a handy one-page guide that explains the differences between traditional and Roth retirement accounts.
What Are the 401k Contribution Limits?
If you’re fortunate enough to work for an employer that offers a retirement plan, such as a 401k, 403b, or 457, they offer contribution limits that are three times the amount you can put in an IRA. These employer-sponsored accounts are incredibly valuable benefits that you should take advantage of, when possible.
For 2017, you can contribute up to $18,000, or up to $24,000 if you’re age 50 or older, to most workplace retirement plans. And for 2018, the limit goes up to $18,500, or up to $24,500 for participants 50 or older.
With tax reform on the agenda of House Republicans, there’s been a lot of discussion about slashing the amount of pre-tax contributions you can put in a workplace retirement plan. There are some proposed changes, but they don’t include a reduction in the amount you can contribute or deduct from taxes.
What To Do When You Contribute Too Much to a 401k
Having the financial ability to over-contribute to a 401k or other workplace retirement plan is a great problem to have! In general, the plan custodian has procedures in place to automatically prevent you from contributing too much.
Unlike an HSA, employer contributions don’t count toward the annual limits I mentioned. So, if your employer has a matching program or makes profit sharing contributions to your retirement play, you can contribute up to the limit, plus what your employer puts in.
If your employer has a matching program or makes profit sharing contributions to your retirement play, you can contribute up to the limit, plus what your employer puts in.
There are a couple of situations that make it possible to over-contribute, such as having two jobs with a retirement plan, or switching jobs during the year. Again, it’s your responsibility to make sure you don’t contribute too much.
Just like with an IRA, if you discover an excess contribution in a workplace retirement plan, you should contact your plan administrator or custodian right away and ask for the excess, plus any earnings, to be withdrawn. You have until your tax filing deadline to correct it and avoid a 6% excess penalty.
You’re required to add any earnings to your taxable income for the year and pay the 10% early withdrawal penalty, if you’re younger than age 59½. So, depending on the timing, your employer may need to amend your W-2 to show the returned amount as taxable wages.
If you don’t become aware of an excess contribution to a 401k before filing taxes, you could end up paying taxes twice—once for the year you over-contributed and again in the year the excess is withdrawn and returned to you. And you also get taxed on any earnings from the excess in the year it’s returned to you.
Yes, it’s complicated. To sum up, making an honest mistake with a tax-advantaged account can wreak havoc if you don’t get it corrected quickly.
Put a note on your calendar to review your HSA, IRA, or 401k at the beginning of December so you have enough time to make necessary changes before year-end. And get professional help when you need it from your account administrator or a low-cost online advisor, such as Blooom.
And if you find a problem that you can’t get fixed before the New Year, getting excess contributions corrected in the first quarter of the New Year is the next best option. You might have some tax to pay, but the faster your account is rectified, the smaller the tax will be.
Free Resource: Ready to save more, eliminate debt, and reach big financial goals? Join Laura in the Dominate Your Dollars community now!
Get More Money Girl!
If you're ready for help managing debt, building credit, and reaching big financial goals, check out Laura's private Facebook Group, Dominate Your Dollars! Request an invitation to join this growing community of like-minded people who want to take their financial lives to the next level.
To connect on social media, you’ll find Money Girl on Facebook, Twitter, and Google+. Also, if you’re not already subscribed to the Money Girl podcast on Apple Podcasts or the Stitcher app, both are free and make sure that you’ll get each new weekly episode as soon as it’s published on the web. The show is also on the Spotify mobile app! Click here to sign up for the free Money Girl Newsletter!
Download FREE chapters of Money Girl’s Smart Moves to Grow Rich
Human Hand Pouring Cola mage courtesy of Shutterstock
Tidak ada komentar:
Posting Komentar