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A critical year-end deadline is approaching for many investors, as failure to meet it may result in an IRS penalty of up to 25%. However, financial experts indicate strategies exist to mitigate or eliminate this potential penalty.
Individuals aged 73 and older are generally required to take Required Minimum Distributions (RMDs) from their pretax retirement accounts. The initial RMD is due by April 1 of the year following the 73rd birthday, with subsequent withdrawals required by December 31st annually. The RMD amount is determined by account balances, age, and IRS life expectancy factors.
This year-end deadline also applies to certain beneficiaries, including non-spousal heirs who have inherited Individual Retirement Accounts (IRAs). Since 2020, these heirs are required to fully distribute inherited IRAs within ten years and must begin taking yearly RMDs in 2025 if the original IRA owner had reached RMD age prior to their death.
Recent legislative changes and IRS guidance have increased the complexity of RMD rules, potentially leading to costly errors.
According to a recent report by Vanguard, missed RMDs represent a significant financial oversight. Aaron Goodman, a Vanguard senior investment strategist, stated that these missed distributions amount to a “billion-dollar mistake.”
Vanguard data indicates that approximately 6.7% of their investors subject to RMD requirements failed to take their distributions in 2024. The average RMD amount for these investors was $11,600, potentially incurring a penalty of up to $2,900, or 25%. While some investors may have satisfied their RMD obligations through accounts outside of Vanguard, the firm estimates that over 580,000 IRA owners may miss their RMDs annually, resulting in potential penalties totaling approximately $1.7 billion.
The standard IRS penalty for failing to withdraw a full RMD by December 31st is 25% of the under-withdrawn amount. However, this penalty can be reduced to 10% if the RMD is corrected within two years by filing Form 5329.
Furthermore, the IRS may waive the penalty entirely in cases of “reasonable error” where corrective action is promptly taken.
Financial professionals recommend taking RMDs as soon as possible if the December 31st deadline is missed. As Sham Ganglani, retirement distributions leader at Fidelity, noted, the IRS is generally receptive to proactive efforts to rectify RMD shortfalls.
