Neglecting to Draw Out Your Mandatory Minimum Distribution (RMD) in Retirement Consequences

Neglecting to Draw Out Your Mandatory Minimum Distribution (RMD) in Retirement Consequences

Are you currently 73 years old (or older) and have funds in an IRA? If the answer to both questions is affirmative, you've got a limited time to act to avoid a potential financial burden. You must withdraw a minimum amount from the specific retirement account by the Dec. 31 deadline.

This timely reminder brings up an important question: What happens if you neglect to satisfy your required minimum distribution (RMD) by the assigned deadline? The IRS comes into play. Penalties ensue.

How do required minimum distributions function?

If you are the owner of an individual retirement account and turned 73 years old prior to 2024, this isn't your first rodeo. Nevertheless, a summary might be beneficial, or even necessary, for anyone who became 73 years old just this year.

To put it simply, you are required to withdraw a minimum sum from most IRAs by the end of each year beginning from the one during which you reach 73 years of age.

However, the amount you need to withdraw depends on your age. For your initial RMD, it's approximately 4% of the previous year's ending balance. This percentage increases every year that follows, although the actual withdrawal amount can decrease over time if these payments exceed the account's growth.

The IRS aims for your retirement account to be completely depleted during the year you turn 120 years old. This hardly ever happens with such precision, considering the unpredictable fluctuations of a retirement account's worth over time.

Your broker should provide you with a specific RMD figure on a tax Form 5498, which is computed based on the account's value at the end of the prior calendar year.

It's essential to note that while there's an annually required minimum distribution, there's no ceiling limit. You can take out as much cash or other assets as you wish. Keep in mind that these are taxable withdrawals, as they come from tax-deferred accounts. The larger the distribution, the more likely you are to move into a higher income tax bracket.

There are exceptions to RMD rules, such as the fact that your initial RMD need not be completed until Apr. 1 of the year following the one in which you turn 73. (After that initial year, the Dec. 31 deadline always applies.)

Additionally, non-inherited Roth IRAs are exempt from minimum distribution requirements, as this money was already taxed before entering these accounts. Additionally, if you are still working and contributing to a 401(k) or a similar workplace retirement plan, these savings accounts may be exempt from RMD rules (at least until you stop working).

Consequences of not taking an RMD

What happens if you disregard the RMD rules? In that case, you'll likely want to demonstrate your adherence to them. No one wants to run into the IRS's wrath. If you fail to take your RMD by the designated deadline, the IRS eventually forces you to do so, imposing a penalty on the untaken amount.

And this penalty is not insignificant. You are liable for a 25% penalty on the difference between the actual amount you withdrew from the retirement account and your calculated RMD.

Don't panic. The penalty is reduced to 10% of the shortfall if it's corrected within two years of its intended completion date. In fact, if you manage to convince the IRS that your failure to take an RMD was due to a reasonable error (and that the error is being rectified as soon as possible once it's realized), you might be able to sidestep the penalty entirely. In such a situation, you would simply need to present your case on a tax Form 5329 in conjunction with your other annual tax documents. This is not a favor or leniency that can be expected to continue indefinitely.

If you own multiple retirement accounts that are subject to RMD rules, you do not need to withdraw an equal amount from each account. If it's more convenient to withdraw more from one account and less from another, that is permissible. The IRS is only concerned that the correct total amount is withdrawn from all of your applicable IRAs in aggregate.

But how does the IRS even know yours is one of the accounts that ought to be subject to RMD rules? Each year, your broker or retirement plan manager reports updated information about these accounts to the federal government's tax authority. Although you may temporarily dodge the organization's attention for a while, the agency will eventually uncover the truth, and probably sooner rather than later. It is ultimately simpler and more cost-effective to simply be proactive with regards to your RMDs rather than risk incurring the ire of the world's most powerful debt collector.

Regardless, if you are required to take an RMD in 2024, the countdown has begun. It would be wise to reach out to your IRA service provider as soon as possible, just to ensure the transfer is completed or the check is issued by Dec. 31.

If you fail to take your required minimum distribution (RMD) by the deadline, the IRS will impose a penalty on the untaken amount. The penalty for not taking your RMD on time is a significant 25% of the difference between the actual amount withdrawn and the calculated RMD.

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