How to Handle the Excess Accumulation Penalty
Understand the process for addressing the tax penalty from a missed retirement distribution, including the specific steps required for corrective action.
The excess accumulation penalty is a tax the Internal Revenue Service (IRS) can impose when an individual does not withdraw a sufficient amount from their retirement account after reaching a certain age. The penalty’s purpose is to ensure the government eventually collects income tax on funds in tax-deferred retirement plans. Since contributions and earnings in these accounts are not taxed upfront, the government mandates withdrawals to prevent indefinite tax deferral.
This penalty is triggered by a failure to take a Required Minimum Distribution (RMD). When an account owner neglects this annual withdrawal, the IRS may levy the penalty on the amount that should have been taken.
The Required Minimum Distribution Trigger
A Required Minimum Distribution, or RMD, is the minimum amount that federal law requires you to withdraw annually from certain retirement accounts. The obligation to take an RMD is the direct trigger for the excess accumulation penalty; if you take your full RMD on time, the penalty does not apply.
The RMD requirement applies to a range of tax-deferred retirement plans, including:
- Traditional IRAs
- SEP IRAs
- SIMPLE IRAs
- 401(k)s
- 403(b)s
- Governmental 457(b) plans
A notable exception is the Roth IRA, which does not require any distributions for the original account owner during their lifetime.
The age to begin taking RMDs is determined by your birth year. Under current law, individuals born between 1951 and 1959 must start their RMDs at age 73. For those born in 1960 or later, the starting age is 75. Your first RMD must be taken by April 1 of the year after you reach the required age, with all subsequent RMDs due by December 31 each year.
Different RMD rules apply to individuals who inherit retirement accounts. Beneficiaries often face a complex set of withdrawal requirements that depend on their relationship to the original owner and the owner’s age at death.
Calculating the Penalty Amount
The calculation of the excess accumulation penalty begins with identifying the “shortfall.” This figure is the difference between the RMD amount that was required to be withdrawn for the year and the amount, if any, that was actually withdrawn. If no withdrawal was made, the shortfall is the entire RMD amount.
Under the rules established by the SECURE 2.0 Act, the standard penalty is a 25% excise tax on this shortfall amount. This is a reduction from the previous 50% penalty. The law provides an incentive for promptly fixing the error. If the account owner withdraws the shortfall amount within a specific “correction window,” the penalty is reduced from 25% to 10%.
This window ends on the last day of the second year following the year of the missed RMD, though it can close sooner if the IRS formally demands payment or assesses the penalty.
For example, if your RMD for the year was calculated to be $20,000 and you did not take any distribution, the shortfall is $20,000. The standard penalty would be $5,000, which is 25% of the shortfall. If you discover the error the following year and withdraw the $20,000 within the correction window, the penalty is lowered to $2,000, or 10% of the shortfall.
Reporting and Paying the Penalty
When you owe the excess accumulation penalty and are not eligible for a waiver, you must report and pay it to the IRS. The process is handled through IRS Form 5329, “Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.” You should use the version specific to the tax year in which the RMD was missed.
The penalty for a missed RMD is calculated in Part IX of the form. You must complete Form 5329 and attach it to your annual federal income tax return, such as Form 1040. The penalty amount calculated on the form is then transferred to your Form 1040 and becomes part of your total tax due.
If you are not otherwise required to file a tax return, you must still file Form 5329 by itself to report and pay the penalty.
Requesting a Penalty Waiver
The IRS has the authority to waive the excess accumulation penalty if you can demonstrate that your failure to take the RMD was due to “reasonable cause.” The first step is to withdraw the full amount of the missed RMD as soon as you discover the error.
The IRS does not provide a rigid definition of reasonable cause, but it includes situations beyond the taxpayer’s control. Examples that may qualify include a serious illness, a mistake made by the financial institution holding your account, or receiving incorrect advice from a tax professional. Simply forgetting or not knowing about the RMD rule is less likely to be accepted as a valid reason.
To formally request the waiver, you must still complete and file Form 5329 for the year of the shortfall. However, instead of calculating the penalty, you enter “0” on the line for the tax due. Next to that line, you should write “RC” (for Reasonable Cause) and the amount of the RMD shortfall.
Attaching a letter of explanation to your tax return is a necessary part of the waiver request. This letter should clearly state the reason for the missed RMD, explain why it constitutes reasonable cause, and confirm that you have since withdrawn the required amount to correct the error.