Making pre-tax contributions to retirement accounts provides a powerful motivation to encourage taxpayers to save for retirement. Still, deferring taxes on those retirement dollars doesn’t last forever.

Eventually, the law requires clients to start taking required minimum distributions, which are taxable as income. The Internal Revenue Service takes missed RMDs seriously and imposes steep penalties when clients fail to take them.

Those penalties, which have changed in the wake of the Secure Acts, can be substantial, so it’s important that clients understand the rules and have a plan in place to avoid any missed RMD penalties going forward.

RMDs: The Basics

All owners of traditional retirement accounts are required to take lifetime RMDs. That includes IRAs, 401(k)s, Simple IRAs and SEP IRAs — but not Roth IRAs or Roth 401(k)s. The distribution amounts are based on the account value at the end of the previous year and the owner’s life expectancy.

RMDs on 401(k)s are calculated separately, based on the specific account value. When calculating RMDs for IRAs, all of an owner’s traditional, Simple and SEP IRAs are grouped together in arriving at the final RMD amount. The owner can then take the RMD from any IRA.

The original Secure Act increased the required beginning date — the age at which taxpayers must begin taking distributions from traditional retirement accounts — from age 70.5 to 72. After the Secure 2.0 Act, taxpayers have until April 1 of the year following the year they turn 73 to take their first RMD. After that, RMDs are due by Dec. 31. Taxpayers already subject to the RMD rules before the Secure Acts were required to keep taking those distributions.

Missed RMD Penalty Changes

Before the Secure 2.0 Act, the penalty for a missed RMD was 50% of the amount that should have been taken for the year but was not.

The Secure 2.0 Act reduced that penalty to 25% of the missed RMD, and the amount is further reduced to 10% of the missed RMD if the taxpayer takes all missed RMDs and files a tax return paying the required tax and penalty amount before the earlier of:

  • Receiving a notice of assessment of the RMD penalty tax, or
  • Two years from the year of the missed RMD.

Before the Secure 2.0 Act changes, the IRS had authority to waive the 50% penalty if the taxpayer filed a Form 5329 and took all missed distributions.

The agency has indicated that it will adhere to this system despite the penalties having been reduced (possibly because the penalties remain significant even with the changes). Clients should understand that it may still be possible to pay no penalties even with the reduced 25% (or 10%) penalty structure.

Taxpayers with missed RMDs can attach a Form 5329 to their tax return or file it separately, providing an explanation of why they failed to take the distributions.

The Secure 2.0 Act also created a statute of limitations for missed RMD penalties. Before the 2022 law, if a taxpayer did not file Form 5329, the IRS had an unlimited amount of time to assess penalties. Because many taxpayers did not know they had missed RMDs, they would never file Form 5329, creating the possibility that the 50% penalty could be assessed for years’ worth of missed distributions.

Under the new law, for taxpayers filing their income tax return with an explanation of how they calculated their RMDs for the year, the IRS has three years from the date of filing to assess penalties. If they fail to attach an explanation of how their RMDs were calculated, a six-year statute of limitations applies.

Tips for Avoiding Missed RMDs

Staying organized can be key to avoiding RMD penalties. Over the years, clients may have opened multiple IRAs with different financial institutions. While the institution calculates the client’s RMD obligation, it may not be aware of IRAs maintained by other institutions. Ultimately, it’s up to the client to make sure that RMDs are accurately calculated.

Clients should be advised to make a list of all existing IRAs — and to consolidate whenever possible. Missed RMDs are much more likely for clients with multiple IRAs who must calculate their RMDs based on the total value of those accounts.

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