For all individuals who have an IRA or other type of retirement plan, there comes the dreaded day when they turn 70-1/2 and need to begin taking their Required Minimum Distributions (RMD). They’ve invested prudently and deferred paying their taxes all these years, and now it’s payback time. You see, when their IRA was born, it came out with a twin brother (or rather, Uncle: Sam!). And now, their “brother” wants his share of the pie for having allowed them to defer the taxes all these years.
The year that someone turns 70-1/2, they are required to take their first RMD. The IRS allows them to postpone the first distribution until April 1 of the following year, but they will still have to take their distribution for the first year, which will cause two distributions to be taxable in the same year. If they have a large IRA from which the distributions will be sizable, they will want to avoid this scenario. The way to do this is to simply take the distribution during the year they turn 70-1/2 and not postpone it to the following year.
How much do they have to take? The IRS has provided a chart that lists exactly the minimum amount that must be taken every year although more can always be taken at any time. The RMD starts at 3.649% (calculated by dividing the balance of the IRA by the appropriate factor listed in the chart at the bottom of this article) at age 70-1/2 and increases slightly every year thereafter. This percentage is based on the balance of the IRA as of December 31 of the previous year.
What happens if you miss a distribution? In short, it gets ugly fast! The IRS applies an excise tax of 50% of the amount that should have been taken but was not. If that’s not bad enough, it gets worse. The entire amount of the RMD needs to be claimed as income for the year even though 50% of it will go to the IRS as a penalty!
Is there any relief if an RMD was missed? Possibly. If the error was an honest mistake or outside of the tax payer’s control, the IRS should allow the penalty to be waived. I say “should” because the IRS makes the final decision as to whether it will waive the penalty. The tax payer needs to file Form 5329 with a letter explaining the circumstances.
In summary, don’t miss an RMD. Set up the RMD as an automatic distribution by the financial institution to avoid the possibility of error. Finally, when requesting an RMD or setting it up to be distributed automatically, don’t wait until the last minute. Allow for a 30 or 45 day processing time in case something goes wrong. This will allow for plenty of time to identify any potentially expensive errors before it’s too late.
