It’s smart to take advantage of tax-deferred growth through retirement accounts. But for most people, once you hit age 70 ½ the party ends and you have to take required minimum distributions. If you don’t, you’ll get socked with a whopping 50% penalty. According the Investors Business Daily, over 15,000 taxpayers didn’t comply with the law last year and they had to cough up over $25 million dollars in penalties. That stings. Here’s how to make sure you never get clobbered like that from the IRS.
1. Understand the Rules
Once you reach age 70 ½ you have to start taking mandatory (taxable) withdrawals from retirement accounts in most cases. These are known as RMDs – required minimum distributions. Even if you are still working at that age, the government needs you to comply with these rules. If not, they’ll ding you 50% for every dollar you don’t take.
For example, if your RMD for this year is $10,000 and you only take out $4000, your penalty on the $6000 you did not take out will be $3000. Bad vibe.
Even if you aren’t 70 ½ you still have to take RMDs out of your IRA if it’s a Beneficiary IRA account. If you don’t comply you will get hit with that 50% penalty.
There are a few exceptions to this rule but not many. Sometimes you can delay taking your RMD if your retirement money is in a 401k and you are still working. This doesn’t apply to many people but you should always consult with your tax advisor to make sure you are following the requirements.
2. How much money must you withdraw?
There are different rules depending on the type of IRA you have. Traditional IRA RMD rules differ from Beneficiary IRA RMD rules. They aren’t that complicated but believe it or not, many custodians get it wrong – especially when it comes to calculating the RMD rules for Beneficiary IRAs. That’s why it’s always smart to double check the number yourself.
3. How to make sure you don’t blow it.
I always suggest that my clients put their RMD on autopilot. Most custodians have forms that allow them to calculate and send you the RMD automatically. You can have this payment sent monthly, quarterly, semi-annually or annually. The cool thing about this approach is that the custodian automatically re-calculates your RMD each year so all you have to do is mosey on down to your mailbox and pick up your check.
Some people don’t want to be tied down to these pre-arranged withdrawals and I understand that. However, since you have to take the money out during the year anyway, why not make it easy on yourself and put it on auto pay? It’s just one less thing to have to worry about.
4. What if you blew it anyway?
The IRS is not a benevolent organization. Still, if you have a reasonable excuse for your lapse you just may be able to get the Treasury to forgive and forget.
Let’s look at the example above. Assume you failed to satisfy your RMD by $6000 in 2014 and you discover this in 2015. At that point you’d take out your normal RMD for 2015 plus the $6000 you forgot to withdraw in 2014. All this income is reportable in 2015. Simple.
At this point, file a Form 5329 and request the penalty waiver. You do this in the year you discover the problem rather than amend your prior return. When you file that form, make sure you include a detailed explanation as to why you made the mistake. Was there a death or illness in the family? Did something happen with catastrophic consequences that made it difficult or impossible to fulfill your RMD requirement?
Keep in mind that IRS has some wiggle room but if you don’t have a very good reason you probably won’t get the waiver. Sorry Charlie. See point 3 again. Just set it up on automatic so this never happens to you. OK?
How do you take your RMDs? Have you ever encountered a problem like this? What happened?