"Penalties for Failed RMDs Reduced" by Julie Jason
Originally published: August 18, 2023 (distributed by Andrews McMeel Syndication)
If you are a regular reader, you'll know that when I discuss IRAs or 401(k)s or taxes generally, I'll remind you that you need to review your situation with your tax adviser. It's hard to generalize about taxes since your tax return is unique to you. Plus, tax rules continue to change.
For example, for as long as I can recall, I've been warning you about the excise tax (penalty) on insufficient required minimum distributions, or RMDs. That's the tax that penalizes you if you don't withdraw the proper amount each year from your tax-deferred retirement accounts after you reach a certain age -- or if you inherit a retirement account at any age.
So, here we are, with a major change in the rules that affects us all starting right now. Thanks to SECURE Act 2.0, which was signed into law at the end of 2022, the penalty for failing to take enough money out of your tax-deferred IRA is now set at a rate of 25%, reduced from 50%.
"Even at 25%, it is still a significant penalty, warranting care to comply with RMD requirements," said Mark Luscombe, principal analyst at Wolters Kluwer Tax & Accounting.
This is how the IRS points out the change on the IRS website (read the quote to the end):
"If an account owner fails to withdraw the full amount of the RMD by the due date, the amount not withdrawn is subject to a 50% excise tax," quoting the IRS website (tinyurl.com/yfwcubn4). "SECURE 2.0 Act drops the excise tax rate to 25%."
The 2023 formula works this way:
Jim, age 75, forgets to take any of his RMD in 2023 by the Dec. 31 deadline. His penalty is 25% (not 50%) of the RMD. For example, if his RMD was to be $20,000, he would owe the U.S. Treasury an excise tax of $5,000 -- still a large amount, but only half of the amount ($10,000) he would have owed under the pre-SECURE Act 2.0 rules.
Again, that's still a hefty penalty, but only one-half of what it was before SECURE Act 2.0's change. The change is a big deal. And, here's why our legislators made this happen.
According to a March 29, 2022 report from the House of Representatives' Committee on Ways and Means (tinyurl.com/9bprn8fn), under Reasons for Change for the RMD excise tax:
"The Committee recognizes that in many cases, failures to take a required minimum distribution are inadvertent. The Committee thus wishes to reduce the overall excise tax that applies to such failures, in particular in the case of an individual who discovers such a failure and takes steps to correct it."
One open issue is whether the IRS will be amenable to requests for waiver of the penalty.
"With the 50% penalty, the IRS had been willing to waive the penalty for a showing of reasonable cause for noncompliance and taking corrective action to come into compliance," explained Luscombe. "There was some concern that, with a lower penalty, the IRS might be less willing to waive penalties. However, in updating its frequently asked questions on required minimum distributions, the IRS left the waiver of penalty question, question 9, intact, indicating that the IRS probably plans to continue its waiver program in a manner similar to what was done in the past."
These frequently asked questions can be found on the IRS website at "Retirement Plan and IRA Required Minimum Distributions FAQs" (tinyurl.com/yfwcubn4).
The waiver Luscombe refers to involves Form 5329, "Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts." A taxpayer can request a waiver of an excise tax by showing "reasonable cause" for why the RMD was not taken by the due date. More details can be found in the instructions for Form 5329 (tinyurl.com/2p8p7cwj).
Note that Form 5329 and its instructions for the 2023 tax year, the first involving the new 25% penalty, are not out yet, according to an IRS spokesperson.
Next week, we'll talk about another SECURE Act 2.0 change that reduces the 25% penalty to 10% in limited cases.