There are several ways you can end up with a missed required distribution and a pile of penalties and tax-time confusion.
- take RMDs on time to avoid penalties
- There is a required minimum distribution (RMD) that was not taken by the account owner
- There is a required minimum distribution that was not taken by a beneficiary of an inherited account, including an inherited Roth IRA
- The account owner is using a substantially equal payment plan (72(t) plan) to avoid the 10% early distribution penalty and did not take the full amount for the year
RMDs that are not taken each year by the account owner or beneficiary get hit with a penalty of 50% of the amount not taken. The penalty is reported on IRS Form 5329. The penalty can be waived for good cause. To have the best chance of getting the penalty waived, an IRA owner (or beneficiary) should immediately take the missed distribution(s), file the form for each year there was a missed distribution or shortfall, and attach a letter requesting the waiver.
When an account owner uses the 72(t) plan, the required distribution is not subject to the 50% penalty. Instead, if all or part of the total amount due for the year is missed, then the account owner will be subject to the 10% early distribution penalty retroactively on all 72(t) distributions taken from the IRA prior to age 59 ½. Again the penalty is reported on Form 5329. Unlike the 50% penalty, there is no waiver of the 10% penalty.
These three items are the same in the income tax treatment of the distributions. Retirement income is taxable in the year in which it leaves the retirement account – not in the year in which it was supposed to be taken. You don’t go back and amend a tax return for a missed distribution. It is taxable in the current year.
For example, Forgetful Fran did not take her RMDs for 2012 and 2013. Her tax preparer, Alert Archie, notices that there is no 1099-R for 2013 when he does her taxes in 2014. He figures out that she has missed two years of RMDs. He has her take those distributions now in 2014. He will not amend Fran’s return for 2012 to add in the forgotten RMD. He also will not include the 2013 RMD on her 2013 return when he prepares it. The distributions will be included in her 2014 income because that is the year she took the distributions. In certain circumstances, that can be a second penalty on a missed distribution. You might pay more in income tax because you have to lump all those distributions into one year. This could also affect other income sensitive items on the tax return such as deductions, credits, phase outs, etc.
So be careful out there. Avoid unnecessary pain and tax bills. Take your RMDs on time.
This article is from Ed Slott and Company. The authors are Beverly DeVeny and Jared Trexler.