If you have a tax-deferred retirement account, such as an IRA, SEP IRA, SIMPLE IRA, 401(k), or 403(b), you are required to take annual distributions by the end of the calendar year once you reach a certain age. However, the rules for these withdrawals can be complicated. The simple explanation is that you take the account balance as of Dec. 31 the previous year and divide by a factor for your current age found on the Uniform Lifetime Table provided by the IRS. It is also generally up to you to make sure you have withdrawn the correct amount from the correct account, assuming you do not have a financial adviser guiding you.
What complicates things is when your spouse is more than 10 years younger than you or when you are a beneficiary of an account, and that for some account types, withdrawals can be aggregated while others must be from each account. It is highly recommended that most investors consult a financial adviser or tax professional to ensure they are fulfilling their RMD each year.
The penalty for not fulfilling your RMD is 50% of the amount not withdrawn. Furthermore, that amount is still counted in your taxable income, so depending on your other income, you could find yourself paying income tax on the full amount of your RMD, plus paying a significant chunk to the IRS as a penalty.
Despite the draconian penalty for not doing so, some investors still miss taking their full required minimum distribution for the year. Sometimes it is a matter of not withdrawing enough or overlooking an account.
Once you discover the error, calculate your shortfall and withdraw that amount as soon as possible from the appropriate account. The quicker you act to rectify the problem, the more lenient the IRS may be. You will also need to report this on IRS Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts. You should also attach a letter requesting a waiver of the 50% excise tax. The letter should explain the reason you missed the deadline and detail the steps you took to correct the error.
While there is no list of acceptable excuses, the IRS may be lenient if you missed the RMD deadline because of illness, a death in the family, a change in address that disrupted essential communication regarding the RMD, or if you relied on incorrect professional advice. The IRS will notify you if they will honor your request for a waiver or not.
One more thing to note: The recently passed SECURE Act increased the age you must begin RMDS to 72; however, if you have already started your RMDs, this won’t affect you. This change affects those who turn 70 ½ in 2020. The SECURE Act also affects non-spousal beneficiaries of retirement accounts. If you inherit any type of retirement account from someone other than your spouse in 2020, you must deplete the account by the end of the 10th year after death.
RMDs aren’t as easy as most investors think. A qualified adviser can guide you through the process and minimize your chance of making errors.