What Is the Penalty for a Below-Minimum IRA Distribution?

Owners of traditional Individual Retirement Arrangements (IRAs) are required to take withdrawals from their accounts once they reach a certain age. These mandatory withdrawals are known as Required Minimum Distributions, or RMDs. The rules ensure that individuals do not indefinitely defer taxes on the funds within these retirement accounts. Failing to withdraw the full RMD amount by the annual deadline can lead to a penalty.

The Penalty for an RMD Shortfall

When an IRA owner fails to withdraw the full RMD for a given year, the IRS imposes an excise tax on the portion that was not withdrawn, which is referred to as the shortfall. Under rules from the SECURE 2.0 Act, the standard penalty is 25% of the RMD shortfall. For example, if an individual’s RMD was $20,000 and they only withdrew $5,000, the shortfall would be $15,000. The penalty would be 25% of this amount, resulting in a $3,750 tax.

The penalty rate can be reduced if the mistake is corrected in a timely manner. The law provides for a lower 10% penalty if the account owner withdraws the RMD shortfall and files a corrected tax return within the “correction window.” This window ends on the last day of the second year following the year in which the RMD was missed. Using the previous example, if the $15,000 shortfall is withdrawn within this period, the penalty would be reduced to $1,500.

This two-tiered penalty structure encourages prompt correction of distribution errors. The calculation is straightforward, focusing only on the difference between the required amount and the amount actually taken. It is important for IRA owners to determine their precise shortfall before they can calculate the potential penalty.

The Process for Requesting a Penalty Waiver

The IRS has the authority to waive the penalty for an RMD shortfall if the account owner can demonstrate that the failure was due to “reasonable cause.” To seek this relief, the individual must show the error was understandable and that they are taking appropriate steps to fix the mistake. Examples of reasonable cause include a serious illness, mental incapacity, or a verifiable error made by the financial institution serving as the IRA custodian.

The first action is to correct the shortfall by withdrawing the entire missed RMD amount from the IRA as soon as the error is discovered. This withdrawal should be taken as a separate distribution and not combined with the current year’s RMD. The amount withdrawn will be taxable in the year it is distributed, not the year it was originally due.

After taking the make-up distribution, the next step is to request the waiver by filing IRS Form 5329, Additional Taxes on Qualified Plans. This form must be filed for the tax year in which the shortfall occurred. When completing the form, the filer should calculate the shortfall amount but enter “$0” on the line for the penalty tax. Next to this line, they must write “RC” (for reasonable cause) and the amount of the shortfall.

A letter of explanation must be attached to Form 5329. This letter should be concise and state why the RMD was missed, providing details of the reasonable cause. It must also confirm that the shortfall has been corrected, specifying the date and amount of the make-up withdrawal.

Reporting and Paying the Penalty

For individuals who do not qualify for a waiver, the penalty must be reported and paid using IRS Form 5329. This is the same form used to request a waiver and is used to calculate the tax owed on the RMD shortfall. The calculation is performed in Part IX of the form.

To complete the form for payment, the IRA owner will enter the RMD amount and the amount actually distributed. The difference is the shortfall. The filer then calculates the tax by multiplying the shortfall by the applicable penalty rate, either 25% or the reduced 10% if the correction was timely. This final figure is the excise tax that must be paid.

The completed Form 5329 is filed with the individual’s annual federal income tax return, Form 1040, for the year the shortfall occurred. The penalty amount from Form 5329 is transferred to Schedule 2 of Form 1040. The payment for the penalty is submitted with the overall tax payment for that year’s return. If an individual is not required to file an income tax return, they can file Form 5329 by itself and submit the payment.