I’m guessing that your Individual Retirement Account (IRA) has not been a top priority recently. At this time of year, most of us get so wrapped up in, well, wrapping, as well as buying, decorating, cooking, preparing, cleaning and hosting, that we barely have time to think at all!
But if you rang in the new year without paying any attention to your IRA, you may have missed an important deadline. With expensive consequences.
By law once you reach ago 70½, you are required to begin taking a minimum amount out of your traditional IRA every year. In most cases, the deadline for taking your annual Required Minimum Distribution, or RMD, is Dec.31.
The exception to this deadline, is if this year you are making your very first RMD. To be exact- and in this case it really matters- the deadline for this first withdrawal is April 1 of the year after you reach 70½.
For instance, let’s say you turned 70 in May of 2013, that means you are 70½ in November 2013. Thus, you have until April 1, 2014 to take your 2013 RMD. (1)
After your first withdrawal, each subsequent one must be completed no later than Dec. 31 of that year. If you qualify to delay taking your initial RMD until April, you will have to take two withdrawals next year- the one for 2013 and the one for 2014.
You Inherited the IRA
Now let’s say you never contributed a dime to the IRA. Instead, it belonged to your mom who left it to you when she died. Technically, it isn’t even yours. In fact, your mom is still listed as the owner and you are named the “beneficiary.”
Nonetheless, the same rule about taking a Required Minimum Distribution by Dec. 31 each year still applies. No matter how old you are (3? 23? 53? 83?), the beneficiary of an inherited IRA must begin withdrawing a certain amount no later than December 31st of the year after the IRA owner died.
So, if mom died in 2012, your first RMD must be taken by Dec. 31, 2013.
Serious Consequences & How to Avoid Them
Whether the IRA is your own or inherited, failure to withdraw an RMD by the deadline results in one of the most onerous penalties in the tax code: 50%. That’s right. If you were supposed to take out a minimum of $4,000 and- oops!- did not do so, you have the privilege of writing the IRS a check for $2,000. Plus, of course, the income tax you owe because you withdrew money from a pre-tax account.
If you made this common mistake, don’t think the IRS will never notice. It might take a while, but the agency will eventually catch up with you. That’s because IRA custodians have to report which accounts are in RMD mode.
The IRS has a lot of flexibility to waive the penalty on a missed or late RMD. For instance, you could qualify for getting the penalty waived if you were affected by a natural disaster and records were lost, or you were in the hospital. Perhaps you had a death in the family. Or, you might have received incorrect advice from a financial advisor or IRA custodian. Waivers have even been granted to individuals who were unable to take their RMD because they were in jail!
The point is, you have a much better chance of escaping the 50% penalty if you contact the IRS before they contact you.
There are some simple- but specific- steps you have to take.
Correct Your Mistake ASAP
If you missed the RMD deadline, the first thing you need to do is withdraw the required amount as quickly as possible.
The minimum you have to take out of the IRA depends on several factors, such as whether it is your account or you inherited it, your marital status, etc... In most cases, the custodian of the IRA will help you calculate the amount. If you want to figure the amount yourself, head to the IRS website, and look for the “Forms and Publications” tab. Click on this and then enter “590” in the search box.
Publication 590 covers the basic IRA rules. Scroll down to the “Life Expectancy” tables in Appendix C (starting on p.93). Find the table that applies to you. For instance, if you inherited the IRA, you will use the “Single Life Expectancy” table. Locate your age as of the year you were supposed to take the RMD. Next to this, you’ll find your “Life Expectancy.”
For instance, say you were 53 years old in 2013 and neglected to take your minimum withdrawal from the IRA your mom left you. As you can see on the chart, your life expectancy is 31.4 years.
Next, you need to know what the inherited IRA was worth at the end of the previous year, i.e. December 31, 2012. If you don’t have a copy of the year-end statement, the IRA custodian can tell you. The minimum you should have withdrawn in 2013 is calculated as follows:
IRA Value on Dec. 31 of previous year/life expectancy factor
In the above example, if Mom’s IRA was worth $50,000 at the end of 2012, your 2013 RMD was: $50,000-31.4 = $1,592.36 (Note that the penalty for missing RMD deadline in this example exceeds $780!)
Some custodians will process an RMD request over the phone while others require you to do this in writing. Withdraw this amount immediately and remember that you will have to report this amount as “income” when you fill out your 2014 tax return.
Tell the IRS You Made a Mistake and Ask for Forgiveness
Once you know what you should have withdrawn, notify the IRS by filling out Form 5329. Don’t freak out! This form looks long and scary, but it’s used to report and correct a lot of different things. All you have to do is zero in on the section that deals with forgetting to take an RMD from an IRA.
It’s handy to have a copy of the instructions for Form 5329. On page 7 you will find the heading “Required Distributions.” Further in this section is a sub-heading entitled “Waiver of Tax.” The information here will guide you to the exact lines you need to fill out.
Note that when submitting Form 5329, you also need to attach a brief explanation as to why you failed to take the necessary withdrawal. Let the IRS know you have already taken steps to correct this by requesting that the custodian send you your RMD. (Assuming this is true.) It might also be a good idea to have a tax professional look over your paperwork to ensure you have covered all the details.
What About a Roth IRA?
While the owner of a Roth IRA never has to take a withdrawal, if you inherit a Roth (and are not the spouse(2)), the same rules about RMDs apply. The difference is that there is no federal income tax on the amount withdrawn.
Missing the RMD deadline on an inherited Roth IRA would be a crying shame because you would be subject to a 50% penalty on a withdrawal that is tax free
You are not limited to withdrawing just the “required minimum” amount. You can always take out more.
RMDs apply to a number of other accounts in addition to IRAs. For more information read this.
1. If your birthday fell in the second half of 2013, i.e. July through December, the deadline for taking your first RMD is April 1, 2015.
2. If the spouse inherits a Roth IRA, s/he has the option of rolling it into her/his name. At that point, s/he is considered the “owner” of the IRA and as such, there is no RMD.