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Important year-end deadlines are looming for many investors, and skipping them could result in penalties of up to 25% from the IRS. But experts say there are ways to reduce or even eliminate it.
Most retirees must begin taking so-called required minimum distributions (RMDs) from their pre-tax accounts when they reach age 73. The first RMD must be paid by April 1 of the year after you turn age 73, and subsequent withdrawals must be made by December 31. RMDs are based on your balance, your age, and the IRS’s “life expectancy factor.”
The year-end RMD deadline also applies to certain heirs who inherit an individual retirement account, including non-spouse beneficiaries such as adult children. Starting in 2020, these heirs must empty their inherited IRAs within 10 years. If the original IRA owner reaches RMD age before death, they must begin RMDs each year in 2025.
But experts say changes in the law and IRS guidance could make RMD rules even more confusing, making mistakes more costly.
“Missing RMDs is a billion-dollar mistake,” Aaron Goodman, senior investment strategist and research team leader at Vanguard, said in a report released by the firm earlier this month.
According to the report, in 2024, approximately 6.7% of RMD-age Vanguard investors will have missed their annual withdrawals.
The average RMD for these investors was $11,600, with potential penalties of up to 25% of $2,900, the report found. However, some investors may be able to meet their RMD requirements through non-Vanguard accounts.
Vanguard estimates that there are approximately 8.7 million IRA owners of RMD age. Translated into a 6.7% missed RMD rate starting in 2024, the company estimates that more than 580,000 IRA owners could skip their RMDs annually, resulting in total penalties of up to approximately $1.7 billion annually.
How to reduce or eliminate IRS penalties
If you don’t withdraw your RMD in full by December 31st, the IRS penalty will be 25% of the amount you should withdraw.
However, the IRS says the tax rate can be reduced to 10% if the RMD is “timely amended” within two years and a Form 5329 is filed.
The agency said that in some cases, the agency may waive the 25% or 10% penalty entirely if the RMD shortfall was caused by a “reasonable mistake” and you took “reasonable steps” to correct the mistake.
In any case, if you miss the Dec. 31 deadline, you should take your RMD “as soon as possible,” Shyam Gangrani, Fidelity’s retirement distribution lead, previously told CNBC. “When you’re doing the right thing, (the IRS) seems to be willing to cooperate,” he said.
