Your Required Minimum Distribution (RMD) is the minimum amount that must be annually withdrawn from your qualified retirement account upon reaching age 70½. Typically, these withdrawals are made from an Individual Retirement Account (IRA), a Simplified Employee Pension (SEP) IRA or SIMPLE IRA.
Realizing that unintentionally not taking one’s RMD is a common occurrence there are steps one can take to possibly avoid paying the penalty. However, the guidelines to rectifying this oversight are technical and the steps must be performed exactly as described in order to have any IRS penalty waived. The penalty for a first-time missed RMD generally is 50% of the missed amount – this could be substantial as it can also include interest on the missed amount.
The most common reason to miss an RMD is having been misinformed or simply not being aware of the requirement, which can also apply to non-spouse beneficiaries (i.e. IRA inheritance recipients).
If one’s spouse did not take the RMD, the surviving spouse must do so for that calendar year by December 31. However, this distribution must be reported under your Social Security number, not the spouse's. The year-of-death RMD will be calculated using your spouse's age and life expectancy.
Similarly many non-spousal beneficiaries are notoriously unaware that their first RMD must be issued by Dec. 31 of the year after the IRA owner dies.
Although the IRS refuses to consider not having been informed or not understanding distribution requirements to be valid excuses, first-time offenders can apply for a waiver.
What You Can Do
While some may be aware of this thanks to a notification from their IRA custodian, not all custodians actually issue such communication or do so in a timely fashion. Consequently if a distribution is not taken, as noted, a penalty (plus interest) may apply.
Similarly, while many IRA owners are told to take their first RMD by April 1st of the year following the year they turn 70 ½, in most cases there’s no follow-up to ensure the distribution actually occurred. In either case, the correction process is the same.
The first step is to actually withdraw the missed RMD. This must be done in order for the IRS to consider granting penalty relief. This then needs to be formally reported to the IRS on Form 5329. One does not need to file an amended tax return. The RMD income is to be included on the return for the year of distribution, along with the RMD for the current year.
Form 5329 is to be filed with your annual return for the year the missed RMD was finally distributed or you can submit it as a stand-alone return. Upon completing Form S329, follow these steps:
- Report the RMD that should have distributed (line 52).
- Report any amount that was distributed before the deadline (line 52).
- In the parentheses (line 54), write “RC” (Reasonable Cause) and list the amount you wish to be waived. If requesting a complete waiver enter “0.”
- Report the penalty that is due (line 55). Again, if you are requesting a full waiver, enter “0.”
- Include a brief statement with the return explaining how the mistake occurred, steps you’ve taken to correct it, and how you plan to be sure it does not happen again. Be honest, brief and direct in your correspondence. Maintain a respectful, business-like tone.
- Do not pay the penalty when requesting a waiver. Wait for the IRS to examine your return. It will then issue a formal notification as to whether you have received a waiver or need to pay a penalty.
Not all IRS negotiations are black-and-white, which is why it is important to present a factual case. Although the IRS states that a waiver may be granted if ”reasonable circumstances exist,” it has not published guidance as to what constitutes reasonable circumstances. Further, the IRS does not issue public opinions on approved waivers. However, if this is a first-time mistake (including one covering multiple years), you did not intend to dodge the tax rules, and the mistake is promptly corrected, you may receive a waiver. Either way, it can pay to ask. The key is asking in the right manner.
If you do not wish to fight the IRS alone or would like to speak with a tax professional, please contact our office. We would be pleased to recommend a tax professional to you or discuss reaching your other personal finance goals:/ 845-627-8300.
Caveat: Roth IRAs do not require withdrawals until after the death of the owner -- more on this in a future blog.