One of the best parts of a 401(k) or traditional IRA is that you can deduct contributions from your taxable income in the year you make them (but traditional IRAs have criteria that must be met). It's a way to save money on taxes and proactively save and invest for retirement.
However, in exchange for this tax break, the IRS expects its money on the back end, so it taxes withdrawals from those accounts in retirement. To ensure it happens, the IRS has put required minimum distributions (RMDs) in place. Unfortunately, not everyone follows the RMD rules -- and it's often costly.
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When do RMDs kick in?
RMDs begin the year in which you turn 73 years old. When you hit that age, you'll have until April 1 of the following year to withdraw the required amount.
For example, if you turn 73 this year, you'd have until April 1, 2027 to take your RMD. After the first year, you must take the RMD by Dec. 31 each year.
What happens if you don't take your RMD?
Failing to withdraw the required amount will result in a penalty of 25% of the amount you failed to withdraw. For instance, if you were supposed to withdraw $35,000 and only withdrew $5,000, you'd owe 25% on $30,000 ($7,500).
If you correct your mistake (i.e., take the required amount), the penalty could be reduced to 10%. In this case, the fee would be $3,000 (10% of $30,000) instead of $7,500.
According to research from Vanguard, failure to withdraw RMDs have cost Americans as much as $1.7 billion annually. In 2024 alone, almost 7% of people with a Vanguard IRA missed their RMDs, with an average tax penalty of more than $1,100.
Although taxes (ideally) go to good causes, there's no need to gift the IRS with an extra $1.7 billion annually if it can be avoided. That's money that's much better spent by people in retirement.
What you can do to help ensure you don't miss the deadline
It's a bit harder to miss 401(k) RMDs because many plan providers are proactive, calculating the amount and notifying you when it's time to take the withdrawals. However, when it comes to an IRA -- where calculating the amount and actively taking withdrawals falls on you -- it's best to set up an automatic distribution plan with your financial institution (Vanguard, Fidelity, etc.). Contact your broker directly to discuss how you can do this.
People have many things going on in their lives, so sometimes missing RMDs is a matter of truly forgetting. Being proactive and automating the process as much as possible can help you skip past avoidable penalties.
