The New Rules for Missed RMDs

Key Takeaways

• All traditional IRAs are subject to required minimum distributions. Roth IRAs and Roth 401(k)s are never subject to RMDs. 401(k)s are, but there are ways around that. If you’re still working for a company, they can be delayed till retirement. But other than that, IRAs are the main focus of the RMDs.
• It used to be that if you missed your required minimum distribution, the penalty was 50% of the amount you should have taken out but didn’t.
• Secure 2.0 lowered that penalty, but there’s still a way where the IRS can go back to the other system and waive the whole penalty if you make up the back distributions and show a reason. You have to file Form 5329 and attach it to your return.
• One way to avoid missing RMDs is by consolidating your IRAs.

Christine Benz: Hi, I’m Christine Benz from Morningstar. The penalties for missing required minimum distributions from tax-deferred accounts recently changed. Joining me to discuss what you need to know about these penalties and how to avoid them is tax and IRA expert Ed Slott. He is the author of a new book called The Retirement Savings Time Bomb Ticks Louder.

Ed, thank you so much for being here.

Slott: Great to be back here. Thanks.

Which Accounts Are Subject to Required Minimum Distributions?

Benz: It’s great to have you here in person. Before we get into some of these penalties and the changes that have recently come to penalties, let’s talk about the accounts that are subject to required minimum distributions and the ones that aren’t.

Slott: Well, all IRAs are, traditional IRAs. Roth IRAs, never. Roth 401(k)s, never. 401(k)s are, but there are ways around that. If you’re still working for a company, they can be delayed till retirement. But other than that, IRAs are the main focus of the RMDs.

What Happens if You Miss Your RMD?

Benz: Let’s talk about how the penalties have changed. It used to be that if you missed your required minimum distribution, you’d have to pay, what, 50%?

Slott: Fifty percent. It was draconian. It was unbelievable. It was so high that I think even the IRS felt bad about it. I only saw one case ever where they assessed it, and it was only because the person had a representative or a tax advisor that didn’t understand it and asked IRS to assess the penalty because they thought they would give them some other benefits. So, IRS said, “OK, if you insist.” But other than that, they rarely assessed it, because even they had to think losing half a year, you know, it’s crazy.

Benz: Right.

Slott: The penalty was 50% of the amount you should have taken out but didn’t. And remember who this affected; it affects beneficiaries, too, but generally older, seniors getting into a new phase of life. They’ve been putting money in and putting money in, now the rules are so confusing. So, if they missed it and made up the shortfall, IRS—they have to file a Form 5329—would waive the penalty in almost every case.

Now, Secure 2.0 lowered that penalty down. I know, it’s still a large penalty, “Oh, only 25%,” but even 10% if you make up the missed distribution within two years. But there’s still a way where IRS can still go back to the other system and waive the whole penalty if you make up the back distributions and you show a reason. You have to file Form 5329 and you attach it to your return. You could actually file it as a separate return, but most people would attach it to their return. And you have to give a little explanation. You don’t have to overdo it. Just, you know, a death in the family, there was an illness, I was confused about the rules, bad advice from my advisor. In fact, there was one case recently that an advisor took over a new account, and they updated the account with the new financial company, and they put the person’s date of birth as Jan. 1, whenever they took it, 2000, when the person was born in 1939. And it was off by 60 years of life expectancy. The proposed penalty was over $100,000. So, mistakes happen, and IRS realizes that. You just have to say, I took the back distributions, and they will waive it. IRS has already said, “We’ll still stick to that deal.”

We don’t know about the lower 10% penalty, because they were very generous and liberal with the 50%, which is almost understandable. But I wonder if they’re going to be as nice and liberal when the penalty is only 10%. I’d rather pay 50% on nothing than 10% on something.

Benz: Right.

Changes to the RMD Penalty With Secure 2.0

Slott: But then there was another snag that came out, Secure 2.0. Because the problem was, and I guess Congress and IRS realized this, people weren’t filing Form 5329. So, there was no statute of limitations. And it happens. I remember having a client years ago, who was 80 years old, came in new. I just met him. I said, where are your RMDs? “Do I have to start?” And it was 10 years already, and they just didn’t know. So, IRS said, “Well, if you file Form 5329 to get us to waive the penalty and take the back distributions, we can waive the penalty.” But if you don’t file Form 5329, even though you file your personal return, the statute never begins to run. So, they fixed that. They said, all right, you know, that’s a problem. People wouldn’t know they missed an RMD, so they wouldn’t know to file Form 5329. The statute could go back indefinitely. And by the way, this only applies, this new statute, for three years and six years, two different versions, for 2022 and later. So, the 50% penalty is still out there.

So, what happens is now they have these two versions. They say you can get a three-year statute of limitations, which means they can only go back three years from the date you file your personal tax return. It won’t hinge on the 5329 anymore. But you have to make up the distributions, but you also would have to attach an explanation of how you calculated a list of all your IRAs, the balance, your age—nobody’s doing that that I know of. So, if you don’t do that, it falls to the six-year statute. So now, you’d have to make up six back years. Nobody has done that yet because we’re not six years out from when Secure 2.0 started. But it created this mess of confusion. So, I would just tell people to be really diligent about making the right calculation.

But you could see how people make mistakes. They have IRAs all over the place. In fact, I saw you on a program, I was telling you earlier, where you said this may be one of the reasons to consolidate your IRAs, so you don’t have them out there. You go to the bank or the broker, and they will do the calculation for you, but they don’t know what you have at the other place, at this place. They don’t know the whole story. So, really, it’s best to consolidate to make it easier for yourself. It makes it a little more complicated if you have a 401(k) subject to RMDs, that has to come from the 401(k). IRAs have a special rule where you can take your RMD based on the value of all your IRAs, including SEP and simple IRAs, figure it on that, but you can take the RMD from any one or combination of them, but you have to know what the whole RMD is. This is very complicated for seniors. Now that the age is raised to 73, people are older who are entering this cycle, so you can see it’s a recipe for disaster.

Tips to Make Sure You Don’t Miss Your RMDs

Benz: Definitely. Consolidation seems like a great point. Any other tips for people who want to be sure that they do not miss their RMD?

Slott: Well, you would take an inventory of all your accounts and maybe get some professional guidance on that. But you have to tell them, you can’t forget about certain accounts that are out in left field somewhere you forgot about, and that’s where consolidation comes in. Because right now, you don’t need a lot of IRAs. People had them years ago because they felt they got certain investments in this one and a toaster in that one or whatever they got. Now you can diversify all in one IRA, which I think was your point on the program you were on, and this way makes it a lot easier if you know you only had to calculate your IRA RMD on one IRA and have somebody check the calculation. And then, if you really want to make extra double belt-and-suspenders sure, file the 5329 anyway with an attachment showing the IRS how you made the calculation, at least that would lock in the three-year statute.

Benz: Well, Ed, helpful advice as always. Thank you so much for being here.

Slott: Thanks.

Benz: Thanks for watching. I’m Christine Benz from Morningstar.

Watch How the DOL’s Fiduciary Rule Affects Your Old 401(k) for more from Christine Benz.