If you have money in a traditional retirement account, required minimum distributions are something you'll have to start dealing with at age 73 or 75, depending on your year of birth. And warning: They can be a huge pain.
The reason required minimum distributions (RMDs) exist is that you get a tax break on the money that goes into a traditional individual retirement account (IRA) or 401(k). The IRS wants to tax that money eventually, so it forces savers to take withdrawals at a certain point.
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The annual RMD deadlines are very easy to follow. But if you miss one, you should know that the consequences could be pretty severe.
The penalty for missing RMDs
RMDs are due every year by Dec. 31. That's a pretty simple deadline to keep track of, but you may get thrown off because the rules are different for your first RMD.
The IRS allows you to defer your first RMD to April 1 following the year of the birthday that triggers that requirement. So, let's say your RMD age is 73 and you turn 73 in July of 2026. You can delay your first RMD to April 1, 2027. Your second RMD will then be due on Dec. 31, 2027.
What sometimes confuses people who defer is that they assume they've met their RMD requirement for the year by taking that withdrawal in April. If you push off your first RMD to the following year, though, you will need to take two RMDs that second year -- one by April 1 and the second by Dec. 31.
If you don't take either RMD on time, you risk a 25% penalty on whatever funds you don't remove from your retirement account. And if you have a large balance, that penalty could be huge. A $40,000 RMD you don't take, for example, could leave you with a $10,000 penalty. Ouch.
How to avoid missed RMDs
You'd think it would be easy to keep tabs on your RMDs, given that they're due by the end of the year each year. But forgetting RMDs is still a risk.
To avoid penalties, set up automatic RMDs. Most financial institutions allow you to do this. You can arrange for your RMDs to come out as a single lump sum, quarterly distributions, or monthly payments -- the choice is typically yours.
Of course, if you do miss an RMD, it's in your best interest to correct the mistake as soon as you can. If you fix it within two years, the IRS will typically reduce your penalty to 10%.
But that could still end up being a large sum of money, depending on the size of your RMD. So, your best bet is really to avoid getting penalized in the first place.
