Retirement account penalties cost Americans billions every year. Most can be completely avoidable. The good news is that once you know the rules, most penalties are easy to avoid. Here are the five most common 401(k) and IRA penalties that catch people off guard and exactly how to sidestep them.
1. Early withdrawal penalty
This is the penalty most people know about, and for good reason. If you take money out of your retirement account before you turn 59½, the IRS typically hits you with a 10% early withdrawal penalty on top of the regular income taxes you’ll owe.
So, let’s say you take out $10,000 from your Traditional IRA at age 45. Not only do you pay income tax on that withdrawal, but you also owe an extra $1,000 in penalties.
There are a few exceptions, such as using funds for qualified higher education expenses, certain medical costs, or a first-time home purchase (for IRAs only, up to $10,000). Generally, retirement funds are meant to grow until you reach retirement age.
How to avoid it: If you’re under 59½ and need cash, carefully consider the potential consequences before accessing your retirement accounts
2. Missing required minimum distributions (RMDs)
Once you hit a certain age, the IRS expects you to start pulling money out of your retirement accounts, even if you don’t need it yet. These are called Required Minimum Distributions (RMDs)
For 2025, the age to begin RMDs is 73. That means the year you turn 73, you need to take your first distribution by April 1 of the following year. After that, you have to take one every year by December 31.
Miss your RMD deadline, and the IRS charges a penalty of 25% of the amount you should have withdrawn. This can drop to 10% if you correct it within two years, but that's still a massive hit.
Real-world example:
Let’s say your RMD for 2025 is $8,000, but you forget to take it.
- Penalty: $2,000 (25% of $8,000)
- Plus, you’ll still owe income tax on the $8,000 when you eventually withdraw it
That penalty can drop to 10% if you correct the mistake within two years, but it’s still a hit most people would rather avoid.
How to avoid it: Set reminders for yourself well before your RMD deadlines. Many retirement account providers will even automate your RMDs for you and can set up automatic withdrawals. Also, if you wait until April 1 to take your first RMD, you'll have to take two RMDs that year (one for the prior year by April 1, and one for the current year by December 31). This could push you into a higher tax bracket.
3. Excess contribution penalties
Contributing to your retirement account helps you save for the future, but it’s important to stay within the annual limits for 401(k)s and IRAs, as exceeding them can result in additional taxes.
For 2025, the limits are:
- 401(k): $23,500 ($31,000 if you’re 50 or older)
- IRA (Traditional or Roth): $7,000 ($8,000 if you’re 50 or older)
If you contribute more than that, the IRS charges a penalty of 6% of the excess amount for every year the extra money stays in your account.
So, if you accidentally put $1,000 too much into your IRA, you’ll owe $60 each year until you remove it.
How to avoid it: Double-check your contributions, especially if you’re contributing to multiple accounts or switching jobs mid-year. If you do go over the limit, don’t panic. You can usually fix it by withdrawing the extra contributions (and any earnings on them) before the tax filing deadline.
