Every year, traditional IRA owners must take a required minimum distribution, or RMD, from their IRA after they turn age 70½.
If you fail to remove this mandatory distribution by the Dec. 31 deadline, you will owe a 50 percent penalty. Thankfully, if the mistake is caught and proper action is taken, this is one penalty that you can usually avoid. The IRS has the authority to waive the 50 percent RMD penalty when the shortfall is due to a “reasonable error.”
The first thing you should do after discovering your RMD was missed is take immediate corrective action. Calculate the shortfall, and then remove that amount as soon as possible from the IRA. Next, file tax form 5329. This form can be filed with your tax return or by itself. As long as you’re requesting that the 50 percent penalty be waived, payment does not have to be made when the forms are filed.
Along with the form 5329, you should attach a letter, explaining the shortfall and the steps taken to rectify the error. There’s no formal guidance on what a “reasonable error” is, but some potential explanations that might pass the IRS scrutiny include: illness, a death in the family, a change in address that disrupted essential communication regarding the RMD, or that you relied upon incorrect professional advice.
The final step in what hopefully will be a successful waiver of the 50 percent penalty, is to indicate in the letter that you are now aware of the rules and will take RMDs correctly going forward.
You can expect to receive a notice from the IRS a few months after submitting the form 5329, and very likely it will confirm that the IRS has indeed waived the penalty.
Good luck and the next time be sure you pay more attention.
• Mike Piershale, ChFC®, RFC® is President of Piershale Financial Group. If you have financial questions on this column contact us at Piershale Financial Group, Inc., 407 Congress Parkway, Crystal Lake, IL 60014. You may also email firstname.lastname@example.org.