What Is the RMD Penalty?

The RMD penalty, officially referred to as an excise tax on excess accumulations, is a financial penalty imposed by the Internal Revenue Service (IRS) when an individual fails to take the Required Minimum Distribution (RMD) from a qualified retirement account by the applicable deadline. RMDs are mandatory annual withdrawals that must be taken from certain retirement accounts starting at a specific age, currently age 73 for most individuals. The RMD rules are intended to ensure that retirement funds are eventually taxed, rather than allowed to grow tax-deferred indefinitely.

When an account holder does not withdraw the full amount of their RMD, or takes no distribution at all, the IRS enforces a penalty in the form of an excise tax. This penalty serves as a corrective measure rather than a permanent confiscation, but it can be costly if not addressed properly.

When the RMD Penalty Applies

The excise tax applies when the RMD for a given year is not satisfied by December 31 (or April 1 of the following year in the case of a first-time RMD). It affects most types of tax-deferred retirement accounts, including:

• Traditional IRAs
• SEP IRAs
• SIMPLE IRAs
• Employer-sponsored plans like 401(k)s, 403(b)s, and 457(b) plans

Roth IRAs during the account holder's lifetime are excluded from RMD requirements, although Roth 401(k)s were subject to RMDs before 2024 (new rules eliminate that requirement starting in 2024 under the SECURE 2.0 Act).

The penalty does not apply automatically for all shortfalls. If a distribution was missed or miscalculated due to a reasonable error and the account holder is actively working to correct it, they can request relief from the IRS. However, if no action is taken, or if the request is denied, the penalty stands.

Calculating the Penalty

The standard excise tax for a missed RMD used to be 50% of the amount not withdrawn, making it one of the most severe tax penalties in the Internal Revenue Code. However, under the SECURE 2.0 Act of 2022, this penalty was reduced to 25% starting in 2023, and it can be further reduced to 10% if the error is corrected within a two-year window.

For example, if an individual’s RMD was $10,000 and they only withdrew $5,000, the $5,000 shortfall could trigger a $1,250 penalty (25%). If they recognize the error and take steps to correct it—typically by withdrawing the missed amount and filing IRS Form 5329 within two years—the penalty may be reduced to $500 (10%).

The penalty is calculated on Form 5329, and the taxpayer must report the shortfall, calculate the excise tax, and attach the form to their tax return (or file it separately if the oversight is discovered after filing the original return).

Requesting a Waiver

The IRS does provide a process for requesting a waiver of the penalty, but it is not automatic. Taxpayers must demonstrate that the shortfall was due to reasonable error and that they are taking steps to correct the situation. Along with Form 5329, they must submit a letter of explanation detailing the circumstances and any supporting documentation.

Common acceptable reasons include:

• Medical incapacitation
• Errors by financial institutions
• Lack of awareness due to recent inheritance of an account

The IRS reviews these requests on a case-by-case basis. If the waiver is granted, no excise tax is assessed.

Consequences and Considerations

Although the RMD penalty has been softened in recent years, it remains a serious issue, particularly for retirees who may be unaware of the requirement or have complex portfolios spread across multiple accounts. The obligation to calculate and withdraw the proper RMD amount annually can lead to errors, especially if accounts are not consolidated or monitored closely.

Failure to comply with RMD rules can also have broader financial implications. The excise tax is in addition to ordinary income tax owed on the distribution, and it can create additional paperwork and stress during tax season. Moreover, recurring errors may raise red flags with the IRS.

Some retirees mistakenly assume that because they don’t need the funds for living expenses, they can skip the withdrawal. However, RMDs are about tax policy, not personal need. Even if the distribution is reinvested or placed in a taxable brokerage account, it still must be taken from the retirement account to satisfy the law.

The Bottom Line

The RMD penalty, now set at 25% and potentially reduced to 10% with timely correction, is a significant tax enforcement mechanism aimed at ensuring compliance with retirement withdrawal rules. While recent legislative changes have made the penalty less harsh, it remains important for account holders to monitor their RMD obligations carefully and take timely action to avoid unnecessary costs. Working with a financial advisor or tax professional can help individuals navigate the calculations, avoid penalties, and make informed decisions about withdrawals.