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July 1, 2022

4 Steps to Take to Avoid Paying the Required Minimum Distribution Penalty
Alli Thomas

If you’re retired and over age 72, you’re probably aware that you’re required to take a certain amount from tax-deferred retirement accounts like your 401(k) or traditional IRA. But what if you made a mistake and didn’t take your Required Minimum Distribution? (If you’re not at least 72, you don’t have anything to worry about…yet.)

According to many financial planners and accountants, tax time is usually when RMD mistakes are discovered. And while IRS rules prescribe a 50% penalty for not taking your RMD – meaning you owe the IRS 50% of the amount you should have taken as your RMD – the agency, fortunately, realizes that mistakes can happen and is surprisingly forgiving as long as the right steps are followed. You don’t need to fill out an endless amount of paperwork to request a penalty waiver, either.

What to Do If You’re Not Sure You Took Your Full RMD

1. Use the appropriate IRS worksheet to calculate your RMD. If you discover a mistake, request the distribution immediately. You must withdraw enough from your 401(k) or traditional IRA to meet the annual distribution requirement.

2. Ask your plan custodian to issue a check, rather than an electronic fund transfer. This makes it easier to document that you did in fact take corrective action on the error. Make a copy of the check to submit to the IRS.

3. Write a letter to the IRS providing a “reasonable cause” for the error. You must also include proof of your corrective action, which is why you made that copy of the distribution check. Are there some cases where the IRS is more likely to waive the penalty than others? Yes. You will likely receive forgiveness if your financial institution caused the error. The IRS will also excuse you in most cases because of a serious illness or mental incapacitation.

4. Complete IRS Form 5329. If you discovered your RMD at tax time, you can attach it to your regular return for that year. However, you can do this only if the incorrect or insufficient RMD happened in the same tax year. If not, you’ll have to file a standalone Form 5329. And if you missed or took insufficient RMDs for multiple tax years, you must file a separate Form 5329 for each year.

When Should I Expect a Response?

Don’t expect to hear back from the IRS for several months after you file Form 5329. If you include it with your tax return, you can assume the IRS has accepted if you don’t receive a bill for the penalty. And be sure to be proactive – if the IRS has to reach out to you, it won’t be nearly as forgiving!

Is There Anything Else I Can Do?

Yes! A financial advisor can help you properly calculate your RMD, write a good “reasonable cause” explanation, and ensure that your Form 5329 is filled out appropriately. They can help you avoid RMD mistakes by determining your obligation in advance by putting together a good retirement plan and help ensure that you take your distribution when necessary. Request a no-cost, no-obligation advisor consultation today!

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