The biggest and most common required minimum distribution (RMD) mistake is not starting your RMDs on time. Failing to take your RMD by the designated deadline can lead to significant penalties from the IRS.
Understanding Required Minimum Distributions (RMDs)
Required Minimum Distributions (RMDs) are amounts that you must withdraw annually from your traditional IRA, SEP IRA, SIMPLE IRA, 401(k), 403(b), 457(b), and other defined contribution plans once you reach a certain age. These rules are in place because these accounts have enjoyed tax-deferred growth, and the government wants to ensure it eventually collects tax revenue on those funds.
The Critical Error: Missing the RMD Deadline
The most impactful error individuals make with their retirement accounts is simply failing to take their RMD by the deadline. This oversight, though seemingly minor, carries severe financial consequences.
Historically, the age for starting RMDs was 70½. However, legislative changes have adjusted this. As of 2023, the age for beginning RMDs stands at 73, and it is slated to increase further to 75 in the future. This change can sometimes lead to confusion, causing individuals to miss their first RMD.
Why Missing Your RMD Is Costly
The penalties for failing to take a timely RMD are steep and serve as a strong deterrent:
- Significant Excise Tax: The IRS imposes an excise tax of 25% on the amount that should have been withdrawn but wasn't. For example, if your RMD was \$10,000 and you missed it, you could face a \$2,500 penalty.
- Reduced Penalty Relief: In some cases, if the mistake is corrected promptly, the penalty might be reduced to 10%, but this is not guaranteed and requires specific actions and IRS approval.
- Lost Investment Potential: The money that was supposed to be withdrawn sits idle, potentially missing out on other investment opportunities or being managed without proper tax considerations.
- Complex Correction Process: Correcting a missed RMD involves filing specific forms with the IRS, which can be time-consuming and add to administrative burdens.
Key RMD Age Milestones
Staying informed about the changing RMD age rules is crucial for effective retirement planning.
| Year RMD Age Change Effective | RMD Starting Age | Impacted Birth Years |
|---|---|---|
| Before 2020 | 70½ | Born before July 1, 1949 |
| 2020 (SECURE Act) | 72 | Born July 1, 1949 – 1950 |
| 2023 (SECURE 2.0 Act) | 73 | Born 1951 – 1959 |
| Future (SECURE 2.0 Act) | 75 | Born 1960 or later |
Note: For employer-sponsored plans, if you are still working for the employer sponsoring the plan, you may be able to delay your RMD until you retire, regardless of age, unless you own more than 5% of the company.
How to Avoid This Critical Mistake
Preventing RMD errors requires proactive planning and diligent monitoring:
- Know Your RMD Age: Determine your precise RMD start age based on your birth year and current tax laws.
- Mark Your Calendar: Set reminders well in advance of the RMD deadline (typically December 31st each year for subsequent RMDs, with a grace period for your first RMD until April 1st of the year following your RMD start age).
- Automate Withdrawals: Many financial institutions allow you to set up automatic RMD withdrawals, which can help ensure compliance.
- Consult a Professional: Work with a financial advisor or tax professional who specializes in retirement planning. They can help calculate your RMDs, track deadlines, and advise on optimal withdrawal strategies.
- Review Account Statements: Regularly check your retirement account statements for RMD reminders or calculations provided by your custodian.
- Understand First RMD Timing: Your first RMD can be delayed until April 1st of the year following the year you reach your RMD age. However, if you delay, you will have to take two RMDs in that subsequent year (the first one by April 1st and the second one by December 31st), which could push you into a higher tax bracket.
By understanding the rules and taking proactive steps, you can easily avoid the significant penalties associated with missing your RMD deadline. For more detailed information, you can always refer to the official IRS RMD guidelines.
