No Fooling – Don’t Forget to Take Your First “Required Minimum Distribution” by April 1st
Generally, if you turned 70 ½ during 2014 and have a traditional IRA or other qualified retirement plan, you will need to take your first required minimum distribution (RMD)[1] by April 1 of this year.[2] This rule applies whether you actually need the money or not. You may be surprised to learn that you will also need to take your 2015 RMD by December 31 of this same year. It’s not uncommon for people to be surprised or confused by RMD rules and, if you don’t get it right, there can be some serious tax implications.[3]
Why Minimum Distributions are Required and the Rules
The purpose of the RMD is to prevent taxpayers from keeping their retirement accounts indefinitely. Basically, our government would like those taxes they previously let you defer. The RMD rules were implemented to make you use the money you saved for your retirement while you are retired rather than end up as an inheritance for your beneficiaries later on.
So, the RMD rules establish the minimum amount of money you must withdraw each year from your IRA or retirement plan each year once you turn 70 ½ years of age. The deadline for your first distribution is April 1 of the year following the year in which you turn 70 ½ and is referred to as the “required beginning date.”[4] After that, you must take an annual RMD by December 31 in each calendar year. The amount of your RMD will be will depend on the value of your IRA account as of December 31 of the prior year and on your life expectancy, as determined per the Uniform Lifetime Tables supplied in IRS Publication 590-B.
Excise Tax of 50 Percent
Taxpayers who fail to take their first RMD by the April 1st deadline may find themselves subject to a significant excise tax. Known as the “Additional Tax on Excess Accumulation in Qualified Retirement Plans,” it is “equal to 50 percent of the amount by which such minimum required distribution exceeds the actual amount distributed during the taxable year.”[5] This means that if you don’t take your RMD, or if you don’t take the full amount, the IRS will impose a 50 percent excise tax on the amount that was not distributed.
Illustration: A single taxpayer who turned 70 ½ in late 2014 had $1,000,000 saved in her traditional IRA by December 31, 2013. Using the Uniform Lifetime Tables, she must take her required minimum distribution of $36,496 by April 1, 2015. If she does not, the 50 percent excise tax will apply and she will owe $18,248 in excise tax – in addition to any regular income tax she owes on her RMD amount. Importantly, April 1, 2015 is the deadline for her first RMD related to taxable year 2014. She still needs to take her 2015 RMD by December 31, 2015. If she misses both in 2015, the excise taxes can be substantial.
Mistakes Happen
While most taxpayers do not miss their RMD deadline, a missed deadline or insufficient RMD is not uncommon. Some taxpayers may be unaware of the RMD deadline or that it applies to them in the current tax year. Some withdraw too little in the calendar year when they must take both their first and second RMDs. Also, some taxpayers get the deadline date mixed up with the April 15 deadline for making IRA contributions and filing their taxes.
It’s helpful to know that trustees of a taxpayer’s IRA or retirement plan are required to either report the amount of the RMD to the account owner or offer to calculate the amount.[6] This information is often provided on Form 5498: IRA Contribution Information. However, while most trustees mail Form 5498 in January, there are some who mail Form 5498 as late as May – well after the April 1 deadline.
How to Waive the 50 Percent Excise Tax
If you make an error with your first or later RMDs and the excise tax applies, a waiver of the excise tax may be available under certain circumstances using a two-prong test.[7] First, reasonable cause must be established to explain why the RMD was not taken.[8] A definition of reasonable cause for the purposes of RMD isn’t provided in the Internal Revenue Code and the Treasury Regulations only slightly elaborates, calling it a “reasonable error.”[9] However, the Treasury Inspector General has noted in one of its reports that reasonable error may include things “such as illness or a major life event.”[10], [11]
The second prong of the test is whether the taxpayer has taken reasonable steps to remedy the shortfall.[12] This can be relatively simple. For instance, remedying the shortfall would include contacting the trustee to request the full RMD[13] amount.
To request a waiver of the 50 percent excise tax on excess accumulations, you must File IRS Form 5329: Additional Tax on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts. This should be filed along with your income tax return. You should also attach a statement explaining the circumstances of your missed RMD and how the error was reasonable. You shouldclearly detail the steps you have taken to remedy the shortfall.
A waiver of the 50 percent excise tax is not automatic. The IRS will review your statement along with Form 5329 and decide whether or not to grant your request for a waiver. However, while there is no guarantee a waiver will be granted, with an excise tax of 50 percent looming, it is,at the least, worth a try.
[1] IRC Section 401(a)(9)(A).
[2] IRC Section 401(a)(9)(C).
[3] There are exceptions and the RMD rules do not apply to Roth IRA accounts.
[4] IRC Section 401(a)(9)(C).
[5] IRC Section 4974(a).
[6] IRC Section 408(i); Treas. Reg. Section 1.408-8, Q&A-10.
[7] IRC Section 4974(d).
[8] IRC Section 4974(d)(1).
[9] Treas. Reg. 54.4974-2, Q&A 7.
[10] A Service-wide Strategy is Needed to Address Growing Noncompliance with Individual Retirement Account Contribution and Distribution Requirements, Treasury Inspector General for Tax Administration, Reference Number 2010-40-043, March 29, 2010.
[11] In our experience, reasonable cause is not just limited to illness and major life events.
[12] IRC Section 4974(d)(2).
[13] Your trustee may use the term “Minimum Required Distribution” or MRD.