Common Errors That Lead to Unexpected Tax Bills

An Individual Retirement Account (IRA) is one of the most powerful tools for long-term financial planning. Yet despite its advantages, it’s also a highly regulated and detail-heavy structure—meaning even small mistakes can be very costly. In the U.S., approximately 58 million households own an IRA, and every year, thousands of errors are reported related to form filing, account classification, or improper transfers and distributions.

Retirement expert Denise Appleby, CEO of Appleby Retirement Consulting, emphasizes that most mistakes are not due to negligence, but rather a lack of awareness or attention. According to her, basic controls and periodic reviews can prevent losses in the tens or even hundreds of thousands of dollars.

The IRS Form Everyone Ignores – and Why That’s a Problem

IRS Form 5498 is a critical reporting document that should not be overlooked. It details all IRA activity during the year—contributions, conversions, transfers, fair market value, and required distributions. Despite its importance, many ignore the form since it is typically sent at the end of May, well after tax returns have already been filed. This timing leads to unintentional errors, as essential data gets overlooked. Appleby strongly recommends not only keeping this form, but reviewing it thoroughly and sharing it with your CPA or tax advisor.

A Million-Dollar Mistake Caused by a Name Change

In an episode of Decoding Retirement, Appleby highlighted a real-life case of a woman who opened a Roth IRA, but after changing her name and designating a new custodian, the account was mistakenly reclassified as a Traditional IRA. Believing the account to be traditional, she made deductible contributions and rolled funds into a 401(k)—assuming these were tax-free. Years later, it was revealed the account had remained a Roth IRA, and the transactions were reclassified as taxable conversions. The financial damage: up to $1 million. A simple check of Form 5498, which clearly indicates account type in Box 7, could have prevented the error.

An Annual Review That Can Save You Thousands

Conducting an annual self-audit of your IRA is essential. Review Forms 5498 and 1099-R, ensure the reported account type matches reality, verify all contributions and distributions, and cross-check them with your filed returns. This process typically takes less than an hour, but it can save thousands of dollars, avoid penalties, and prevent future IRS complications. The closer the review occurs to year-end, the easier it is to make corrections in time.

Don’t Forget Your RMDs

Anyone aged 73 or older must take a Required Minimum Distribution (RMD) each year from their IRA. The distribution amount is based on the account balance and IRS life expectancy tables. Despite appearing straightforward, common errors arise from using outdated balances or incorrect tables. Critically, even if your bank or custodian makes an error, you are ultimately responsible. An RMD miscalculation can result in a 25% penalty, although filing Form 5329 with a reasonable explanation can reduce the penalty to 10%, or even eliminate it entirely.

Rollovers from a 401(k)? Watch for Unintended Conversions

Rolling over funds from a 401(k) to an IRA is a common and often beneficial move—but one fraught with red tape. A frequent mistake: requesting a rollover into an IRA, only to have the funds land in a Roth IRA—triggering a taxable conversion the client was unaware of. Additionally, employer plans may include after-tax contributions or employer stock, which require special handling.

Timing is also critical: most rollovers must occur within 60 days. In cases of illness or disaster, the self-certification process may allow for a correction without penalty.

Bottom Line: Every Mistake Is Fixable – If You Act

Managing your IRA requires awareness, responsibility, and a firm grasp of the rules. A once-a-year audit with the right forms and a qualified advisor can prevent major issues. Even long-standing errors—like missing RMDs for ten years or more—can often be fixed with the right documentation and clear intent. As long as you act in good faith, transparently, and promptly, the IRS is usually willing to cooperate.

Understanding your account types and ensuring every rollover or contribution is executed correctly could mean the difference between peace of mind and a retirement filled with unnecessary financial stress.