The Risks of Required Minimum Distributions (RMDs)
Those who own a tax-deferred individual retirement account (IRA) or another type of retirement account must withdraw a minimum amount from that account beginning at age 70½. If the account holder fails to take an amount called the required minimum distribution (RMD) on time, and in the right amount, there can be a penalty. For every dollar not withdrawn, the IRS will charge a 50% penalty tax.
- Owners of a tax-deferred IRA or another type of retirement account must withdraw a minimum amount from that account beginning at age 70½ in order to avoid a penalty tax.
- If a withdrawal is missed, the owner must pay the excise tax, submit a waiver request, or, if they inherited a retirement-account from an owner who died before their RBD, they can switch to the five-year rule and withdraw the full balance of the account by Dec. 31 of the fifth year following the year the retirement account owner died.
- It may not be practical to switch to the five-year rule solely because the RMD deadline was missed.
Steps for Resolving Missed Withdrawals
Retirement accounts are known for their tax benefits, such as the compound effect of tax-deferred growth. However, owners and beneficiaries of traditional, SEP and SIMPLE IRAs, qualified plans, and 403(b) accounts must meet the deadline for taking their RMD. If for any reason you miss your deadline, there are some steps you must take.
Step 1: Pay the Excise Tax
However, if by meeting certain exceptions you are not required to file a tax return as explained in the instructions for filing Form 1040, 1040-SR, or 1040-NR, you must file Form 5329 by itself and pay the excise tax owed. Complete the form with the requested information and enclose your check or money order made payable to the United States Treasury. On the check write your Social Security number, the current tax year, and "Form 5329."
Step 2. Request a Waiver
If you feel that you missed the deadline due to a reasonable cause, you may ask the IRS to waive the 50% excise tax. The request for waiver may be included in a letter of explanation, which you attach to your tax return (Form 1040) along with your Form 5329. When requesting a waiver, do not pay the excess accumulation penalty upfront. Instead, follow the instructions for requesting a waiver in the Instructions for Form 5329. If the IRS does not honor your waiver request, you will be notified.
Step 3: Withdraw the Full Balance
If you are a beneficiary who inherited a retirement-account from an owner who died before their required beginning date (RBD), and you are required to distribute the assets over your life expectancy, you must begin withdrawing RMD amounts by a certain time. That deadline is Dec. 31 of the year following the year in which the owner of the retirement account died. You must also withdraw an RMD amount by Dec. 31 of each subsequent year.
While the excise penalty will generally apply if you did not withdraw the RMD amount on time, the penalty may be waived if you switch to the five-year rule and withdraw the full balance of the account by Dec. 31 of the fifth year following the year the retirement account owner died. Let's look at the following example:
In 2018, John inherited an IRA from his brother Ron who died at age 65. Since Ron died before his RBD, John has two options for distributing the IRA balance:
- John can distribute the assets over his single life expectancy. For most IRA plan documents, this is the default option and is consistent with the provisions of RMD regulations.
- John can distribute the assets by Dec. 31 of the fifth year following the year Ron died.
John chooses the life-expectancy option. The RMD for 2019 is $10,000, but John fails to withdraw any amount by Dec. 31, 2019. If John wants to continue using the life-expectancy method, he will have to pay the IRS an excise tax of $5,000 and must file Form 5329. He may request a waiver if he feels the failure is due to a reasonable cause. John, however, will receive an automatic waiver of the penalty if he withdraws the account balance by Dec. 31, 2018, the fifth RMD-year following the year Ron died.
It may not be practical to switch to the five-year rule solely because you missed the RMD deadline. A competent financial professional can help you determine the best course of action. For example, whether it is more financially sound for you to pay the excise tax so that you continue enjoying tax-deferred growth or tax-free growth in the case of a Roth IRA, or whether it makes more sense to accept the waiver and distribute the assets within the five-year period.
Missing your RMD deadline can be frustrating and costly. To ensure it does not happen, take the necessary steps to make sure your distribution occurs by the applicable deadline. This includes making arrangements with your custodian for systematic or automatic withdrawals to occur on a predetermined date. Submit your withdrawal requests at least two months before the deadline and check your statements to ensure the correct amount was distributed from your account.
Submitting your requests early allows sufficient time for any necessary adjustments. Talk to your financial institution about other ways it can help you to satisfy your RMD requirements.