Posted by: The Life and Legacy Planning Group
The retirement years are supposed to be carefree—but what if you neglected to take the required minimum distribution (RMD) from one or more of your retirement accounts or took a distribution that was lower than required? This could be a costly mistake resulting in a tax penalty of 50% of the amount of the distribution you did not take, which may amount to thousands of your hard-earned dollars. Fortunately, the IRS has provided retirees with the opportunity to seek a waiver of penalties if the proper remedial action is promptly taken.
What Is a Required Minimum Distribution?
The Internal Revenue Code allows people to save for retirement using tax-deferred retirement accounts, including traditional IRAs, 401(k)s, 403(b)s, 457 plans, and thrift savings plans, which allow working people to invest money that can grow tax free for a period of time, deferring any taxes on that growth until a future date. Not only does this allow taxpayers to postpone paying taxes on the income earned in the account, but it also typically results in paying lower taxes for those investments because when the time comes to pay those taxes, i.e. during retirement, most taxpayers are earning less than they were during their working years and are more likely to fall into a lower tax bracket.
Unfortunately, all good things must come to an end: These accounts are tax deferred, not tax free, and the IRS has established 70½ as the age when it will start to collect taxes on distributions that retirees must begin to take. Even if you are not yet retired at age 70½, you must still begin taking RMDs from your IRA account. However, you can delay taking RMDs from your employer-qualified retirement plan, including a 401(k), 403(b), profit-sharing, and 457 plan, until you actually do retire. This exception applies only to a plan sponsored by your current employer—but not the plans of past employers. Whether you are considered to be “still working” is a bit complicated because the IRS has not established a hard and fast definition of what this entails. You should contact the plan administrator to confirm when RMDs are required.
Note: The owners of retirement accounts are required to take their first distribution by April 1 of the year after they turn 70½ years of age (or stop working for the accounts mentioned above). From then on, the RMD deadline is December 31 each year. Keep in mind, however, that if you delay taking your first RMD until April 1 of the year after you turn 70½, you will also have to take the second RMD on December 31st of that same year, so you may want to go ahead and take the first RMD by December 31st of the year you turn 70½.
Unfortunately, hundreds of thousands of retirees are unaware of the requirement to take an RMD, forget to take the required distribution amount, or fail to take the right amount. If a retiree does not take the minimum distribution required by the IRS (or doesn’t take the full amount)—even accidentally—a penalty of 50% of the amount that should have been taken could be imposed. So, if a retiree was required to take a distribution of $10,000 from a retirement account, but failed to do so, the amount of the penalty would be $5,000.
Note: Retirees are not required to take RMDs for Roth IRAs because tax was already paid on contributions made to those accounts. There are withdrawal requirements, but they only take effect after the account owner’s death.
What Should You Do If You Missed an RMD?
Fortunately, the IRS is willing to waive the 50% penalty under certain circumstances—but you must show that your error was “reasonable” and that you are taking “reasonable steps” to correct it.
- Once you discover that you have missed or miscalculated your RMD, you should take the distribution as soon as possible to correct the error.
- File IRS Form 5329, “Additional Taxes on Qualified Plans (Including IRAs) and Other Tax Favored Accounts,” for each year for which you failed to take the RMD. Even if you failed to take the RMDs from multiple accounts, a single Form 5329 is generally sufficient. If your spouse also failed to take an RMD, however, he or she must file a separate Form 5329. Filling out this form can be tricky, and it is easy to make mistakes that could result in a denial of the penalty waiver. We can help you fill in the required forms correctly to increase the chances that your penalty will be waived. Form 5329 can be filed with your income tax return if you discover the error early in the next calendar year, but if the error is not discovered until later, you should file Form 5329 as a standalone form. Do not send in the amount of the penalty with your form.
- Along with your Form 5329 and documentation showing that you have now taken the required distributions, send a letter to the IRS explaining why you did not take your RMD on time. The IRS has not provided a definition of what will be considered a “reasonable error,” but circumstances such as illness, address changes, the death of a family member or some other crisis, or incorrect advice or information provided by the plan’s trustee are the types of explanations that the IRS may deem to have led to a “reasonable error.”
- If the IRS decides to waive the penalty, it will send you a notice to that effect, which you should retain in your tax records.
Rules for Beneficiaries
Owners of retirement accounts must take their RMDs after reaching age 70½, but beneficiaries of retirement accounts (including Roth IRAs) other than the spouse of the account owner generally must begin taking RMDs soon after they inherit those accounts. The first RMD must be taken by December 31 of the year following the year in which the account owner died. Under current law, non-spouse beneficiaries are allowed to stretch the RMDs over their own life expectancies, so the amount of the RMD may be different for the beneficiary than it would have been for the owner. If a beneficiary does not take the RMD, the same steps applicable to owners should be followed to seek a waiver of the tax penalty.
The beneficiaries also must correct any RMDs missed by the owner of the account prior to his or her death but not discovered until after death using the same procedure described above. The beneficiaries should work together with the estate’s executor to remedy the situation: Although a retirement account generally passes by contract and does not become a part of the decedent’s estate, the 50% penalty, if assessed, is a debt of the estate.
Contact Us for Help
A sizeable IRS tax penalty for failure to take an RMD can be like a gut punch to a retiree, as many retirees are on fixed incomes. If you have missed one or more RMDs, we can help you submit the necessary forms and documentation to request a waiver of the penalty from the IRS. In addition, we can provide guidance to help ensure that you are not in danger of missing any future RMDs. Call our office today to set up an appointment to discuss these or any other retirement or estate planning concerns.