Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Despite their best intentions, retirees sometimes miss their required minimum distributions. Joining me to share some steps to take in this situation is Ed Slott, he is a retirement expert.
Ed, thank you so much for being here.
Ed Slott: Great to be back here. Thanks.
Benz: Ed, let's discuss required minimum distributions briefly--which accounts are subject to them and who is subject to them.
Slott: This is great to start off the year knowing all of your accounts that are subject to RMDs, because we find at tax time that's when we hear, oh, I missed, I forgot that account, I forgot this account, I took the wrong amount. This is when we see all the errors. In general, IRAs after 70 1/2 are subject to required minimum distribution. So are 401(k)s if you are not still working. If you are still working, there are exceptions for some people. So, or any other plan, except Roth IRAs; Roth IRAs, that's sort of a big advantage--they are not subject to lifetime RMDs. But your 403(b)s, 457, your 401(k)s and your IRAs are subject to RMDs. Especially, when people start, that's when the confusion sets in, but every year in the beginning of the year that's when we hear, oh, I missed it.
Benz: Right. So, let's discuss what happens if you miss it, because it's not something you want to mess around with. There is a big penalty, right?
Slott: Yeah, it's a 50--and I always say, 5-0 because it sounds like 15, because 50 doesn't sound believable--50, 50% penalty on the amount you should have taken but didn't or any shortfall, let's say. But that penalty can be waived if you do take the right steps.
Benz: We're going to talk about those steps. Say, it's the new year and I realized I didn't take my distribution for last year, what process should I go through, first of all, to let the authorities know and also try to make a case about why I missed it? Actually, there is some leniency ... so let's talk about that.
Slott: The first thing you have to know, people always ask, should I go back last year and take it? Only if you have a time machine. You can't go back to a year and take, and say, I took it that year. So, you can't go back. It has nothing to do with the prior year. And some people say, but don't I have unreported income? No. Unreported income is income you took, but didn't report; you never took this income.
There is no effect on the prior year other than you have a potential 50% penalty. You have to make it up. Currently, as soon as you discover it, you should figure out the amount you were short or whatever the RMD that was missed, and take the makeup distribution immediately. Then, of course, take you regular distribution for the year so you stay on track. And then you report that on what's called Form 5329. It's a tax form where you report the 50% penalty. You tell IRS this was my required amount, this is how much I didn't take, how much I was short, but you don't pay the penalty. Years ago you had to pay and then ask for an abatement …
Benz: Ask for it back. You just show zero, but you must attach a statement saying two thing: number one, that I made up the shortfall, you have to show good faith that whatever I missed, I took immediately upon discovery. Then give a short explanation of why, and IRS waives the penalty in almost every case. They know they are talking about seniors, people over 70 1/2, they got confused, they had a medical issue, a death in the family, bad information from a bank or financial advisor. You just put whatever reason it was and take the missed--well you have already taken the missed distribution--and file that form with your regular tax return.
Benz: There is some leniency, would you say, in terms of getting these penalties waived?
Slott: Oh, yeah. Almost everybody gets the penalties waived. I can't even think of somebody I have ever seen declined. I have seen one case, and it was an oddball case because they didn't understand the rules and they actually asked IRS if they would assess the penalty. It's a long story, but don't ever do that.
Benz: In terms of the paper trail that I want to maintain to try to keep my taxes clear and straight, what should I do in terms of--I'm addressing this missed RMD, but then I also have another RMD coming due for this year ahead. How do I handle that?
Slott: There is no requirement. But what I do on a practical level, I tell people take separate distributions. Take the makeup distribution separately, so it can be better traced if it's ever a question--there is that one. You could mix it in with your current one, but then somebody would have to figure out, well, did they just take too much of the current one and not the other one. Separate them. Take the missed distribution separately and the current one separately so they can be traced.
Benz: Then in terms of avoiding this problem altogether, do you have any tips on that front of things that people who are subject to RMDs can do to avoid falling into this trap?
Slott: First thing, in the beginning of the year, take an inventory of every retirement account you have subject to required minimum distributions. It might be a first year, so you just turned 70 1/2 and you didn't know, or maybe you have that old 401(k) or a 403(b)--you should have an inventory of all the RMDs. That includes if you are a beneficiary. Remember this 50% penalty also applies to beneficiaries. So if you just inherited, you have a required minimum distribution probably starting in the year after you inherited. You should know all the accounts that are subject to RMDs.
But before you take them, going back to something we've talked about on other programs, if you're going to do the qualified charitable distribution, which applies to IRA owners over 70 1/2, do that at the beginning of the year so it can offset the income from your required minimum distribution, because the first dollars out are deemed to satisfy your required minimum distribution.
Benz: Ed, useful discussion. I know this problem crops up for some retirees. Thank you so much for being here.
Slott: Thanks, Christine.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.