When you have just a little bit of financial savvy and a bit of extra cash, you can start to take advantage of what the IRS calls tax-favored accounts. These are special savings accounts you can set up with almost any financial institution which have very nice tax savings built into them. It’s the government’s way of encouraging good financial behavior through offering tax savings when you save money for the future. You only have to agree to a few simple rules. With the retirement savings accounts, called IRAs (Individual Retirement Account), you must agree not to touch that money until you are at least 50 1/2 years old. Likewise, you must start drawing on that account when you reach age 70.
Types of Tax-Favored Accounts
There are tax-favored accounts for medical savings accounts, education savings accounts and other types of retirement accounts. For any of these, all of which come with rules, the penalty for breaking the rules is extra tax and sometimes actual penalties. To report your wrongdoings with the tax-favored accounts use IRS Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.
When to Use IRS Form 5329
Here are some examples of “rules” you can break with tax-favored accounts, causing you to have to file IRS Form 5329…
- you receive an early distribution from your Roth IRA
- you receive an early distribution form a Coverdell Educational Savings Account
- you receive an early distribution from a Qualified Tuition Plan (QTP)
- you contribute too much to your Traditional IRA or your Roth IRA
- you contribute too much to your Coverdell ESA
- you contribute too much to a Health Savings Account or an Archer Medical Savings Account
- you didn’t receive the minimum amount you are required to take out of your retirement plan after hitting a certain age
If any of these describe you, then get a copy of IRS Form 5329 and submit it along with your IRS Form 1040. If you aren’t required to file the 1040, that does not exempt you from having to file IRS Form 5329. For more details, see the IRS Form 5329 Instructions here.