Financial Planning, Retirement

Missing The RMD Deadline Can Be Expensive

12/12/19 12:00 PM

iStock-626627280.jpgWith the end of the year quickly approaching, many older Americans may benefit from our annual review of the Internal Revenue Service’s minimum distribution requirements for popular retirement savings vehicles. Indeed, people can start tapping into their 401(k) and IRA assets penalty-free as early as age 59½, but most individuals will instead allow some if not all of their money to remain in these accounts and continue to grow. Although that can be a great idea, the government will often penalize owners of retirement accounts if they fail to start taking required minimum distributions (RMDs) after having reached age 70½.

Specifically, individuals participating in traditional IRAs, IRA-based plans (SEPs, SARSEPs, and SIMPLE IRAs), and employer sponsored plans (profit-sharing plans, 401(k)s, 403(b)s, and 457(b)s) who fail to receive their full RMDs by certain deadlines could owe the IRS a 50 percent excise tax on the withdrawal shortfall. There are a few plan-specific differences related to company ownership and working status, but as a general rule of thumb your first minimum withdrawal should be made by April 1st of the year following the year in which you turn 70½. Afterwards, including the year in which you took your first RMD by the delayed April 1st deadline, you must receive subsequent RMDs by December 31st of each year.

Put simply, Americans who turned 70½ this year have until April 1st of 2020 to receive their first distribution, while older individuals should have already begun receiving RMDs with another due by the end of this month. These rules also apply to Roth 401(k)s but not Roth IRAs while the owner is alive. Consider consulting with an accountant or other tax professional for additional guidance. The 50 percent penalty can be waived, according to the IRS, if the account owner establishes that the shortfall in distributions was due to “reasonable error and that reasonable steps are being taken to remedy the shortfall.” In order to qualify for this relief, Form 5329 must be filed along with a letter that explains why the deadline was missed.

As for retirees who receive their full RMDs on time and do not have to worry about the 50 percent penalty, tax considerations should still be made since distributions have the potential to raise their taxable income enough to bump them into a higher tax bracket. It is also beneficial to have a plan in place ahead of time for what to do with the funds from your RMD after they are received, e.g. making home improvements, reinvesting the money in a regular brokerage account, donating to charity. All of these considerations increase the importance of working with a professional financial advisor to make sure that your hard-earned money is put to use in a way that is properly aligned with your retirement aspirations.



Sources: U.S. IRS, The Motley Fool, Fidelity Investments

Post author: Charles Couch