The Year-End Retirement Withdrawal Deadline That Can Trigger a 25% Penalty

Once retirees reach age 73, there is a key deadline to remember for required minimum distributions, or RMDs, from a 401(k): December 31. With year-end obligations and holiday distractions, it is easy for the deadline to slip by.

Below is a look at why RMDs matter and what can happen if the deadline is missed.

Why retirees need to pay attention to RMDs

RMDs are mandatory withdrawals from retirement accounts such as a 401(k) or traditional IRA. The amount to withdraw depends on factors including age and account balance. The IRS requires these withdrawals by the end of the year, and missing one can lead to steep penalties.

The required starting age depends on birth year

The rules for RMDs have changed over time. The starting age is now 73 for many retirees, after previously being 72. In the future, the age will rise to 75 for people born after 1960. Most retirement accounts are subject to these rules, although Roth IRAs and Roth 401(k)s are exceptions.

Missing the deadline can be costly

If an RMD is not taken by December 31, the IRS can impose a 25% excise tax on the amount that should have been withdrawn. For example, if the required distribution was $10,000, the penalty would be $2,500. That kind of loss can be especially harmful for retirees on fixed incomes. There is some relief available: if the error is corrected before the end of the next taxable year and Form 5329 is filed, the penalty may be reduced to 10%. In some cases, the IRS may also waive the penalty entirely, depending on the reason for the mistake. A financial planner or tax attorney can help determine whether a waiver may apply.

Your first RMD can be postponed, with a drawback

There is one exception for a retiree's first RMD. The IRS permits the first withdrawal to be delayed until April 1 of the following year. But doing so means two distributions may have to be taken in that same year, which can increase taxable income and possibly push the retiree into a higher tax bracket.

Although delaying the first RMD can give the retirement account more time to grow, it may also create an unwelcome tax bill later. Higher income can also affect Medicare premiums.

Not all retirement accounts require RMDs

Roth IRAs and Roth 401(k)s are not subject to RMDs. Account holders may leave money in those accounts for as long as they wish, since taxes were already paid on the contributions before the money was invested.

A charitable donation can satisfy the requirement

For people over 70.5 with a traditional IRA, a qualified charitable distribution, or QCD, can also meet part or all of the RMD requirement. This allows a direct donation to charity from the IRA, and the amount does not count as taxable income. It can be a useful way to support a charity while reducing tax exposure.

When in doubt, seek professional guidance

If there is any uncertainty about RMD rules, a financial advisor can help. The rules for combining distributions can vary depending on the type of retirement account, which can make them confusing.

A financial planner can also verify earnings and account balances to make sure the correct amount is withdrawn. That can help retirees avoid costly penalties and missed deadlines.