Pennsylvania CPA Journal
Some of the rules for qualified retirement plans recently changed, which means some account owners might have missed taking their required minimum distributions (RMDs). Advisers should especially review the rules regarding RMDs where clients are the beneficiaries of inherited plans.
Recent changes to the rules for qualified retirement plans might mean some account owners have missed taking their required minimum distributions (RMDs) after reaching their required beginning date or after receiving an inherited plan. Luckily, the penalty was revised down by the Setting Every Community Up for Retirement Enhancement 2.0 Act of 2022 (SECURE Act 2.0) to 25% (was 50%) of the excess accumulation for missed RMDs in tax years 2023 or later. The penalty can be further reduced to 10% for such tax years if certain conditions are met.
Clients and advisers should carefully review the rules regarding RMDs where clients are the account owners and the beneficiaries of inherited plans, and apply for a waiver of the penalties for missed RMDs to the extent that the circumstances qualify.
RMDs Under the SECURE Acts
The SECURE Act 2.0 changed the required beginning date (RBD) to April 1 of the year following the year an account owner turns age 73 for those born between 1951 and 1959, and age 75 for those born in 1960 or later, delaying an account owner’s first mandatory withdrawal. However, the original SECURE Act of 2019 (SECURE Act) eliminated the “stretch” distribution treatment for most beneficiaries of inherited qualified plans for decedent-owners who died on or after Jan. 1, 2020. Under the SECURE Act, a beneficiary will be required to take annual RMDs for each of nine years following the year the account owner died if the account owner attained her RBD prior to her death, and then withdraw the balance by the end of the 10-year period. An exemption exists should a beneficiary be a surviving spouse, minor child of the account owner, is disabled or chronically ill, or is not 10 years younger than the account owner.
This rule was waived by the Treasury for calendar years 2021 through 2024. Beginning in calendar year 2025, however, beneficiaries of inherited plans subject to the SECURE Act (with initial account owners who died after Jan. 1, 2020) were required to take their first RMD.
For example, Patty, age 74, died on Nov. 4, 2023, leaving her 401(k) solely to her son, Sonny, who was 52 in 2023 and not chronically ill or disabled. Sonny rolled over the 401(k) into an inherited IRA but, because of the waiver of penalties for tax year 2024, Sonny did not take an RMD that year. Beginning in tax year 2025, Sonny was required to take annual RMDs, with the outer limit for the final withdrawal to occur by Dec. 31, 2033. Under the IRS Single Life Expectancy Table, in 2025, Sonny, then 54 years old, has a life expectancy factor of 32.5. If the inherited IRA is valued at $5.2 million as of Dec. 31, 2024, Sonny’s RMD for 2025 would have been $160,000.
If Sonny forgot to withdraw this amount by Dec. 31, 2025, he would owe 25% of this amount, a $40,000 additional tax on the excess accumulation.
Careful coordination between clients and their advisers should help avoid this type of mistake in the future.
Form 5329 for Additional Tax
The account owner must file Form 5329 to report and pay the additional tax on excess accumulations in the qualified plans. Under Part IX of this form, the RMD amount is reported – reduced by any distributions made during the applicable tax year to the account owner. The additional tax is then calculated based upon the excess accumulation and the applicable tax rate, depending upon whether a reduced tax rate of 10% applies.
An account owner may be eligible for this reduced tax rate if, during the “correction window,” the account owner received the RMD amount and submitted an income tax return reflecting the additional tax owed. The correction window ends upon the earliest of the date of the mailing of the deficiency notice for the additional tax; the date this tax is assessed; or the last day of the second taxable year that begins after the taxable year in which the additional tax is imposed.
A first-step best practice for an account owner is to withdraw the missed RMD immediately upon discovering that it was not withdrawn.
Next, the account owner should complete and submit Form 5329, along with payment of the additional tax owed. The account owner should also submit substantiating evidence, such as account statements, to reflect the RMD amount being withdrawn within the correction window if the reduced 10% penalty is requested. A short, enclosed explanation of why the account owner meets the requirements for the reduced rate would be prudent.
The instructions advise that the account owner is not to include on line(s) 53a or 53b any distributions received after the deadline for the RMD or during the correction window. For qualified retirement plans (other than IRAs), the distributions cannot be aggregated across plans for purposes of meeting the RMD requirements. For IRAs (other than Roth IRAs), while the RMD must be computed separately for each IRA of the account owner, the account owner can generally withdraw the total amount from one or more of these IRAs. For inherited IRAs, only distributions from IRAs inherited from the same decedent can be combined to satisfy the RMD requirements for all inherited IRAs from that decedent.
Clients and their advisers should consider these rules, along with the applicable accounts, to determine if the RMD requirements have been satisfied.
A Waiver for “Reasonable” Cause
The IRS can also waive some or all of the additional tax owed if the account owner can demonstrate that the shortfall in the amount distributed was due to “reasonable error” and the account owner took reasonable steps to remedy this shortfall. The appropriate lines 52a and 52b, and 53a and 53b, should be completed according to the Form 5329 instructions.
On line(s) 54a and/or 54b, however, the account owner should write “RC” and the amount of the shortfall requested to be waived in parentheses on the dotted line next to the applicable line, subtracting this amount from the total shortfall and entering the result on the applicable line. Line 55 is the sum of lines 54a and 54b, and its total represents the amount of tax owed by the account owner. This should be reported on Schedule 2 of Form 1040 for an individual, or Schedule G, line 8, of Form 1041 for an estate or trust.
The most important part is substantiating within a short letter the cause of any reasonable errors and the steps taken to correct the shortfall. Some reasonable explanations might include, but are not limited to, the account owner suffering from cognitive impairment or incorrect information provided by the custodian or trustee of the qualified plan. Corrective steps that could be shared likely include immediate action to take the RMD, such as enclosed checks or account statements showing the exact amount of the shortfall.
The account owner should also reference the timing of the discovery and the distributions. The explanation might conclude with a request for relief through reliance on Internal Revenue Code Section 4974(d), or, alternatively, a request for the reduced tax if the distributions were made during the correction window.
Conclusion
The rules regarding RMDs from qualified plans have become more complex following the passage of the SECURE Act and SECURE Act 2.0. Diligent review of how and when to make RMDs are important tasks for clients and their advisers to review at least annually. If an RMD is missed, or a shortfall is otherwise discovered, clients should consider a timely response and reporting of this shortfall, as well as their options to reduce any additional taxes owed.
Before waving a white flag of defeat, clients may wish to discuss these options, including requesting a waiver of penalties and/or a reduction of the applicable tax rate.
Brian M. Balduzzi, JD, LLM (Taxation), CFP, is a partner with Holland & Knight LLP in Philadelphia and New York. He can be reached at brian.balduzzi@HKlaw.com.