How to Fix a Missed Required Minimum Distribution (RMD)

This is the fourth of four columns discussing the fundamentals of required minimum distributions (RMDs).

This column presents the three steps needed to fix a missed RMD.

SEE ALSO:

• Required Minimum Distribution (RMD) Age and the Required Beginning Date (RBD)
• How the TSP Calculates the Required Minimum Distribution (RMD)

A common mistake made with qualified retirement accounts and traditional IRAs is a missed RMD. When a qualified retirement plan participant l misses an RMD, there are always questions about how to set things right. Over the last five years since 2019, there have been some changes in the law regarding IRA penalties that the IRS imposes on traditional IRA owners and qualified retirement plan participants who miss an RMD.

It needs to be mentioned that a missed Thrift Savings Plan (TSP) RMD will not happen. As discussed in the recent column “How the TSP Calculates the TSP RMD”, the TSP makes sure that any TSP participant who is subject to a TSP RMD will withdraw enough from his or her traditional TSP account to meet their TSP RMD each year.

In particular, a TSP participant who is subject to a TSP RMD in any calendar year (after the first year)must withdraw enough by the first week of December of that year to meet their RMD for that year. If the TSP participant has not withdrawn enough to meet that year’s TSP RMD, then the TSP in early December will send the TSP participant a check for the outstanding TSP RMD balance.

The following are the three steps used for resolving a missed RMD from a traditional IRA:

Step 1: Identify the Missed RMD

Missed traditional IRA RMDs can happen for a variety of reasons. The following are some examples showing how an IRA RMD can be missed:

1. When a traditional IRA owner reaches his or her required beginning date, IRA RMDs must occur. The due date for traditional IRA RMDs is December 31. However, for the first year RMD, the traditional IRA owner is given an extra three months, until April 1st following the year they reach age 73. While many traditional IRA owners are advised by their financial advisers to take their first RMD by April 1 of the year following the year they become age 73, in many cases there is no follow-up to ensure the distribution actually occurs.

2. IRA beneficiaries (including Roth IRA beneficiaries) are also subject to RMDs. SECURE Act (passed into law in December 2019) and SECURE Act 2.0 (passed into law in December 2022) have upended these rules and caused confusion. For example, IRS rules state that many IRA beneficiaries are subject to the “10-year rule” under the SECURE Act using their own life expectancy and must take annual RMDs. The following example illustrates:

Example 1. George owned a traditional IRA and named his brother Felix, three years younger, as beneficiary. Felix is an “eligible designated beneficiary” (EDB) because he is not more than ten years younger than George. George passed away in 2022 at the age of 69 before he was scheduled to take his first traditional IRA RMD. That means Felix, age 66 in the year of George’s death, does not have to worry about taking a 2022 year-of-death RMD for George. However, Felix will have to take an annual RMD based on his single life expectancy starting in 2023. He must then take an RMD every year thereafter. Missing any of these annual RMDs will subject Felix to a penalty. While some IRA beneficiaries are told about annual RMDs in the wake of the traditional IRA owner’s death, few custodians will follow up to ensure the RMD is successfully made and completed.

Step 2: Understand the Penalties for a Missed RMD

SECURE Act 2.0 reduced the penalty for a missed RMD from 50 percent to 25 percent, effective January 1, 2023. In addition, if the missed RMD mistake is corrected in a “timely manner”, the penalty is further reduced to 10 percent. A “timely manner” means that the traditional IRA owner or the traditional IRA beneficiary: (1) Takes the missed RMD; and (2) Files IRS Form 5329 (Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts) by the end of the second calendar year following the year for which the RMD was missed.

It should be noted that if an IRA owner or beneficiary does not have a valid excuse for missing the RMD, then they should pay only a 10 percent penalty. This is because the IRS allows the 10 percent penalty regardless of the reason for the missed RMD as long as the two correction requirements (listed above) are met. Unlike the IRS waiver for relief for reasonable cause, the 10 percent option is not subject to IRS discretion. The following example illustrates:

Example 2. Elizabeth turned 75 in July 2023. She was subject to a traditional IRA RMD for 2023 that should have been taken by December 31, 2023. Elizabeth missed the 2023 IRS RMD and had no excuse. She will owe a 25 percent penalty on the amount of the RMD not taken. However, the penalty will be reduced to 10 percent if Elizabeth takes the RMD by December 31,2025 and files IRS Form 5329 also by December 31, 2025.

The new reduced RMD penalty under SECURE 2.0 applies only to year 2023 and later. For missed RMDs prior to 2023, the penalty remains at 50 percent. The CARES Act waived RMDs for 2020.

Step 3: Request a Waiver of Penalty for a Missed RMD

Before 2023, if an IRA owner or beneficiary missed an RMD, the IRS could impose a penalty equal to 50 percent of RMD shortfall. But the IRS consistently waived the “excess accumulation” penalty if the IRA owner or beneficiary took the RMD and filed IRS Form 5329 with a reasonable explanation why the RMD was missed. In fact, the IRS did routinely excuse the 50 percent penalty without even responding to the filing of IRS Form 5329.

With the passage of SECURE Act 2.0 resulting in the reduction in the penalty from 50 percent to 25 percent, it was not clear whether the IRS would continue to waive the penalty if someone followed the same procedures that had worked prior to 2023, when SECURE Act 2.0 took effect. However, the 2023 version of IRS Form 5329 confirms that IRS Form 5329 can still be used to seek a waiver of RMD penalties.

If a traditional IRA owner or beneficiary decides to pursue a waiver using IRS Form 5329, then he or she does not have to go back and amend a previous year’s Form 1040 income filings. Instead, the first step is to withdraw the missed year’s RMD. Note that the income from the RMD is included on the income tax return for the year of distribution. For example, if a missed RMD from 2022 is distributed during 2024, it will be included in 2024 income. The IRS will not permit any relief from a missed RMD until the RMD is taken.

IRS Form 5329 addresses many different penalty situations for not only IRAs but for other types of accounts such as health savings accounts (HSAs) and Coverdell education savings accounts (HSAs). Note again that IRS Form 5329 should be filed with the annual tax return for the year the missed RMD is taken. It can also be filed as a stand-alone return. If multiple RMDs are missed – that is, missed RMDs occurred over several years – then the IRA owner or beneficiary will have to file a separate IRS Form 5329 for each year an RMD was not taken. The forms can be filed together.

Waiver of Penalty on a Missed RMD

To request a waiver of penalty on a missed RMD or pay a penalty (even if there is no reasonable cause) an IRA owner or beneficiary will need to complete Part IX of Form 5329.

Penalties for missed IRA RMDs can be large, even after the changes that have come out of SECURE Act 2.0. But IRA owners or beneficiaries must take action in order to minimize or eliminate the penalty. They are advised to speak with a financial advisor who is knowledgeable with the new rules, and in particular assisting with the preparation of IRS Form 5329. Needless to say, time spent addressing a missed RMD is time well spent in order to avoid a potentially large IRS penalty.