The IRS penalty for missing a required minimum distribution for many years was 50 percent of the amount that should have been withdrawn from a traditional IRA or a qualified retirement plan but was not. The IRS penalty, known as an “excess accumulation” penalty, was one of the largest penalties that the IRS imposed.
The 50 percent “excess accumulation” penalty was so severe that the IRS rarely assessed it. In fact, the IRs waived the penalty altogether provided the traditional IRA owner made up the RMD shortfall and filed IRS Form 5329 (Additional Taxes on Qualified Retirement Plans Including IRAs and Other Tax-Favored Accounts), presenting a reason for initially not taking the correct RMD. Reasons presented on IRS Form 5329 and acceptable by the IRS included: Confusion over the RMD rules; incorrect advice from an adviser or a financial institution; illness or family medical issues; disability or death.
Penalty Relief Provision Under SECURE Act 2.0
SECURE Act 2.0 passed into law in December 2022, contained numerous provisions affecting IRAs and qualified retirement plans. One provision coming out of SECURE Act 2.0 is the reduction of the 50 percent penalty to 25 percent, and to 10 percent if the missed RMD was made up within two years. The penalty reduction has been in effect since January 1, 2023. The IRS has also suggested that a 100 percent penalty waiver is available for a traditional IRA owner, if the steps (discussed above) are taken.
Another provision of SECURE Act 2.0 that Congress addressed and passed into law is with respect to the statute of limitation (SOL) on assessing an RMD penalty. In general, an SOL determines how many years the IRS can go back to enforce a part of the Internal Revenue Code; in this case, an RMD penalty. With a filed individual tax return, the IRS has a three-year SOL. The SOL is six years when an individual tax return understates more than 25 percent of actual gross income. There is no SOL in cases of fraud or a willful attempt to evade federal income taxes.
It is important to note that before the passage of SECURE Act 2.0, there was no SOL for the IRS to assess an RMD penalty. The filing of an individual tax return (Form 1040) did not initiate an SOL period with respect to the RMD penalty. The only way to get an SOL period started was for an individual to file IRS Form 5329 as part of his or her federal income tax income tax return. In that sense, Form 5329 was considered a separate tax return with its own SOL.
In SECURE Act 2.0, Congress attempted to fix this problem of the SOL RMD penalty by allowing the filing of Form 1040 - with or without Form 5329 - to initiate the SOL period. If Form 5329 is filed as part of Form 1040, then the SOL available with Form 5329 remains in place.
The SOL available by the mere filing of Form 1040 without the filing of Form 5329 is a welcome change. However, this provision passed as part of SECURE Act 2.0 (and effective starting with the filing of 2022 individual income tax returns) is not retroactive according to a recent Tax Court case. This means that for pre-2022 individual tax returns filed without Form 5329 (in which the RMD penalty was 50 percent) remain open for the IRS to assess prior year RMD penalties.
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What is the SOL for Missed RMD Under SECURE Act 2.0?
It appears that SECURE Act 2.0 states that the SOL for missed RMDs, effective starting with the year 2022, is three years from the original filing due date (April 15th) of the individual tax return, or from the actual filing date if the return was filed with an extension. For example, for the 2023 tax year, the SOL for missed RMDs is April 15, 2027, three years from the filing due date of 2023 tax returns (April 15, 2024).
However, the SOL for a missed RMD could be increased to six years if the amount of the RMD penalty omits more than 25 percent of the eventual penalty. As a result, the IRS will have six years to assess an RMD penalty. While a six-year SOL is better than no statute, it is not as good as a three-year SOL.
A traditional IRA owner can still request an RMD penalty waiver from the IRS. However, missed RMDs would have to be made up first, going back as many as six years.
SECURE Act 2.0 SOL Change Applies Only to Traditional IRAs
In addition to not being retroactive, the SECURE Act 2.0 SOL change applies only to missed MRDs from traditional IRAs and not missed RMDs from employer-sponsored retirement plans, such as a 401(k)-retirement plan, 403(b) retirement plan, and the Thrift Savings Plan (TSP). With respect to the TSP, it is doubtful that a retired TSP participant would be subject to an RMD penalty. This is because the TSP automatically processes a TSP RMD to a retired TSP participant who by the first week of December has not taken his or her TSP RMD for that year. For the first year only, the TSP RMD is due by April 1 of the following year. The TSP will automatically send the first year TSP RMD to the TSP participant by March 15 preceding the April 1 deadline if the TSP participant has not taken his or her first year TSP RMD by March 15.
A retired TSP participant who previously participated in other qualified retirement plans (such as a 401(k), 403(b) and 457 retirement plans), must take a separate RMD for those plans. The SECURE Act 2.0 SOL change does not apply to missed RMDs for those plans. Qualified retirement plan participants with missed RMDs will therefore need to file IRS Form 5329 to get the SOL period running.
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Ed Zurndorfer, EA, ATA, CFP®, CLU®, ChFC®, CEBS®, ChFEBC℠: Federal Employee Benefits Expert
A former career Federal employee, Ed has published a staggering 1,200+ separate articles on Federal Benefits and Retirement!
Just “Google” his name, and you are likely to find a plethora of sites that contain his writings. Drawn to its mission to reach, teach
and serve Feds, Serving Those Who Serve is the only financial planning practice with which Ed has chosen to affiliate in over
20 years teaching. In addition to conducting Federal Benefits seminars for Serving Those Who Serve, you can find Ed’s
writings here on our blog in the FedZone, and on Fed-Soup, MyFederalRetirement, FederalNews Radio and NITP.
He is a member of the Maryland Society of Accountants, the National Association of Enrolled Agents, the International Society of Certified Employee Benefits Specialists, the Financial Planning Association, the National Association of Health Underwriters,
and the Society of Financial Service Professionals. Since 1999, Ed has taught many thousands of Federal employees about
their benefits, in person and at Federal agencies all over the country. Ed is a true national treasure.
Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street - Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.