Avoid These 3 Common Required Minimum Distribution (RMD) Mistakes

Retirement accounts like IRAs and 401(k)s come with several benefits for investors. One of the most important is that you can defer taxes on your contributions. Instead of paying taxes on your income in the year you earn it, you can wait until you withdraw your retirement savings to pay taxes, giving you more money to invest in advance.

But you can’t wait forever to pay your tax bill. Finally, the government wants the cut.

That’s why it imposes required minimum distributions (RMDs) on traditional retirement accounts. Seniors must begin withdrawing funds from their accounts and paying taxes on those withdrawals in the year they turn 73. Anyone who inherits an IRA may also be subject to RMDs.

The penalties for not taking an RMD are pretty heavy. You could owe a penalty of up to 25% of the amount you were supposed to withdraw. Plus, you’ll have to make the withdrawal anyway and pay income tax.

If you don’t follow the rules correctly, you could be facing a pretty big tax bill when the IRS catches up with you. And that’s even if you tried your best to follow the rules.

Unfortunately, it is all too common to make a mistake. Here are three big ones that can hold people back from taking RMDs.

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1. Missing your RMD deadline

The annual deadline for required minimum distributions is December 31. But if you’re manually requesting a withdrawal from your financial services provider, you probably want to get a head start on things. Many providers are inundated with all kinds of requests at the end of the year, and delays are not uncommon. It is your responsibility to ensure that funds are withdrawn before the end of the year.

If this is the first year you are subject to RMDs, you will have three additional months to withdraw. The first RMD isn’t actually due until April 1 of the year after you turn 73. However, waiting until the following year to take your first RMD can be a financial mistake. The second RMD is still due at the end of the year, so you’ll face a much larger tax bill that year as a result of the delay.

If you inherited an IRA from someone subject to the RMD after December 31, 2019, and you are not a spouse, minor child, or less than 10 years younger than the original owner, you will also be subject to the RMD. The IRS waived the RMD requirements for inherited IRAs from 2020 to 2024, but they will go into effect in 2025 with the same December 31st deadline.

Even if you’re just one day late, you’ll owe a tax penalty. Correcting the mistake within two years can reduce the penalty from 25% to 10%, but it’s best to avoid it altogether.

2. Withdrawal of funds from a single type of account

Many retirees end up with multiple types of retirement accounts, such as an old workplace retirement account and an IRA. It’s important to note that RMDs apply to each account type separately.

If you have some money in a 401(k) and some money in an IRA, you’ll need to make withdrawals based on the previous year-end balances for each account. You can’t just withdraw from your 401(k) and cover the amount you were supposed to withdraw from your IRA as well.

Additionally, if you inherited an IRA, you will need to take a separate RMD from the inherited IRA and your own IRA. And if you inherited multiple IRAs from multiple people, you’ll need to treat each one separately.

However, you can combine personal IRAs or 403(b)s (but not other types of accounts). If you have an IRA, a SEP IRA, or any other type of IRA, you can make a withdrawal from just one of the accounts to cover them all. And it’s also the same if you have multiple 403(b) accounts.

Making a mistake here is especially costly because you often can’t put money back into retirement accounts. So you’ll have to pay the penalty, withdraw the correct amount, and opt out of fee-free compounding for the money you withdrew from the other account by mistake.

3. Combining RMDs with your spouse

You might combine finances with your spouse and the IRS might even tax your joint income, but when it comes to RMDs, you can’t combine yours and your spouse’s.

You cannot jointly own a retirement account with a spouse. Therefore, each spouse is subject to their own RMD, based on their age and the account balance in their own accounts at the end of the previous year. You can’t withdraw enough from your own retirement accounts to cover the amount your spouse would need to withdraw from theirs, or vice versa.

This is another mistake that comes with significant costs. You or your spouse will have to correct the underdistribution and pay the penalty. Meanwhile, the other person will not be able to return the funds they have withdrawn to the tax-advantaged account.

Knowing the rules can help prevent these mistakes, but if you have any uncertainty, it may be best to consult with a financial advisor. A brief consultation with a fee-only advisor should provide enough information to keep you out of the IRS penalty box.