Four retirement plan tax mistakes to avoid

BOSTON -- As the calendar turns to April, a nation of procrastinators will start working on their taxes.

And when that happens, they'll find retirement plan mistakes that require correcting as well as some last-minute, retirement-plan tactics they can use to lower their tax bill.

Here's a look at some of the retirement-plan tax tactics to employ and mistakes to correct.

Required minimum distributions

Many older and some not-so-old Americans had to take a required minimum distribution from their IRAs in 2010.

And unless you had pre-arranged for your custodian to disburse your RMD automatically, it would have been easy to overlook that requirement. After all, Congress has passed a law waiving RMDs in 2008 and 2009.

And then, in 2010, RMDS were once again required, or at least it was for those for whom the law applied. And not taking your RMDs is a costly mistake: It comes with a 50 percent penalty.

Fortunately, there's a way to correct the mistake according to Ed Slott, editor of investment newsletter Ed Slott's IRA Advisor.

"The very first thing you should do is immediately take what your 2010 Required Minimum Distribution would have been," he recently wrote on his website.

"You should then file Form 5329 with your 2010 income tax return and attach a letter asking for a waiver of the 50 percent penalty. Indicate in the letter that when you realized you did not take your RMD in 2010, you distributed the missed RMD.Don't be surprised if you don't hear from the IRS because you corrected your error."

Fund those retirement accounts

Most people understand the benefit of contributing to a 401(k) or traditional IRA: It lowers your taxable income. But there's another reason why it's important to fund those accounts, Slott said.

"Anything that will lower the modified adjusted gross income also affects your Medicare Part B premium for 2013," he said. "If you lower your MAGI, your premium may not be 'means tested' at all for as much two years hence."

Visit this Social Security Administration website to learn about means testing for higher-income beneficiaries: www.socialsecurity.gov/pubs/10536.html#rules.

Don't forget credits

"With so many individuals electing to put the funding of their retirement nest-egg on hold because they 'can't afford it,' I continue to be surprised about how many are unaware of the Savers Credit, and how it could reduce the funding cost for eligible individuals," said Denise Appleby, the CEO of Appleby Retirement Consulting Inc. and editor of The IRA Authority Newsletter.

Consider, for instance, that an individual with a tax-filing status of married-filing-jointly, with an adjusted gross income up to $33,500 for 2010, can get a nonrefundable credit - Savers Credit - of 50 percent, not to exceed $1,000, of the contribution amount, she said.

"In addition, this individual can get a deduction for contributions made to a traditional IRA," said Appleby. "Knowledge of these benefits can encourage individuals to fund their retirement accounts."

Fund the right account

It's hard to say how many taxpayers fell into this mistake, but there are likely a few who contributed to a nondeductible IRA on their 2010 tax return when instead they should have contributed to a Roth IRA instead.

Why does that mistake need correcting? Well, contributions to both a nondeductible IRA and Roth IRAs are made with after-tax dollars. But the big difference is that distributions from those accounts are taxed quite differently: Distributions from a nondeductible (or more specifically the gains in excess of the contributions) are taxed at ordinary income rates while distributions from a Roth IRA (assuming certain conditions are met) are not taxed at all.

The other mistake that requires correcting occurs when you fund a Roth IRA when your income is too high. "You can withdraw (the contribution), Picker said. "But it would better to move it to a traditional IRA in my opinion."