What Can Go Wrong

Attempting to navigate tax rules without careful attention to detail can result in heavy penalties. Even simple miscalculations can transform tax-free money into a tax nightmare.

“Risk comes from not knowing what you’re doing.” — Warren Buffett

Here are the most common mistakes you need to avoid:

• Violating the Roth Five-Year Rule: You must hold a Roth IRA for at least five tax years before earnings become tax-free, even if you are over 59 and a half. If you withdraw earnings too early, you will pay income tax on that growth.
• Misusing HSA Funds: If you withdraw money from an HSA for non-medical expenses before age 65, you face a severe 20% penalty plus ordinary income tax. After age 65, the penalty disappears, but non-medical withdrawals are still taxed as ordinary income.
• Letting a Life Insurance Policy Lapse: If you borrow heavily against your permanent life insurance and the policy lapses before you die, all the outstanding loans you took out suddenly become taxable income. You must monitor policy performance closely to ensure enough cash value remains to sustain the policy.
• Ignoring Municipal Bond Complexities: While municipal bond interest is exempt from regular federal income tax, it can trigger the Alternative Minimum Tax (AMT) in certain situations. Additionally, as noted in the table above, municipal bond interest still counts toward the formula that determines if your Social Security benefits are taxable.