Taking Required Minimum Distributions? These Mistakes Could Cost You

It seems simple enough: When you turn 73, you must starting withdrawing a specific amount—a required minimum distribution (RMD)—from your tax-deferred retirement accounts, such as a traditional individual retirement account (IRA) or a 401(k) plan. Still, it’s all too easy to make a mistake that has serious financial consequences.

Required minimum distributions are preceded by a number of calculations and classifications. Make an error on any of them and you could withdraw less than is required—and trigger one of the stiffest tax penalties in the book. The Internal Revenue Service (IRS) imposes an excise tax of 50% of any shortfall.

Because of that risk, advisors often suggest erring on the side of caution when it comes to distributions by taking out a little more than the calculated amount. Liberate too much from your accounts, though, and you might face a higher tax bill and limit your nest egg in the long run.

Here’s a rundown of some common RMD errors and the trouble—usually tax-related—they can cause.

1. Delaying Your First RMD

As a rule, you must start taking RMDs in the year you turn 73 if you were born before 1960, and at age 75 if you were born later. However, appreciating that new “distributors” may need extra time to prepare for the withdrawal process, the IRS lets you defer your first RMD to as late as April 1 of the following year.

While that may be convenient, it might not be in your best financial interest. Holding off on that first payment means you have to take two RMDs in less than 12 months—the one you held over to the end of March, and the regular one due on Dec. 31.

If your accounts, and thus their RMDs, are fairly large, “that means potentially two sizable taxable withdrawals in the same year,” says Carol Berger, CFP®, Berger Wealth Management, Peachtree City, Ga. “This could bump [you] into a higher tax bracket,” Berger points out, and possibly subject you to the Medicare surcharge, depending on your modified adjusted gross income (MAGI).

In such a scenario, Berger recommends foregoing the extension. Instead, she says, spread the withdrawals over both years by taking your first payment by Dec. 31 of the year you turn 73.

2. Using an Incorrect Fair Market Value

The RMD for a year is determined by dividing the previous year-end’s fair market value (FMV) for your retirement account by the applicable distribution period. This period is based on your age, and you can find it on the IRS-issued life expectancy tables. The custodian of your retirement accounts usually provides a report of your FMV by Jan. 31 of the following year. However, it can complete that task only with the information it has at hand.

That documentation is sometimes lacking, says Jillian C. Nel, CFP®, CDFA, director of financial planning at Inscription Capital LLC, Houston, Texas. “If there is limited information on the year-end value (i.e., lost statements, movement of accounts, hard-to-value assets within the portfolio), this calculation can be challenging,” says Nel.

Your RMD might also change if you make relevant changes after your FMV was calculated, based on year-end information. However, such late changes are now less common due to changes introduced in the Tax Cuts and Jobs Act of 2017. That legislation banned one of the most common of such maneuvers, called recharacterization—that is, undoing a traditional-to-Roth IRA conversion and changing a Roth IRA back to a traditional IRA to avoid a sudden big tax bite on the converted funds.

Nonetheless, let your custodian know of any transactions within the year that could conceivably affect the RMD you’re required to make by Dec. 31.

3. Mixing Plan Types to Meet RMDs

If you have multiple IRAs or 403(b)s, you’re allowed to combine the RMDs from the same type of account and take a single distribution from one of the accounts. You’re not permitted, though, to withdraw an RMD for an IRA from a 403(b) or vice versa. And you can’t exercise such consolidation when it comes to 401(k)s.

Regardless of account type, you can’t reach across your portfolio and take RMDs required for one type of retirement account from a different type of account.

RMDs and Inherited IRAs

With inherited IRAs, you’re allowed to combine RMDs for multiple inherited/beneficiary IRAs you received from the same decedent—and then withdraw the total from just one of those accounts. However, you cannot combine RMDs from IRAs you inherited from several decedents.

Also, you can’t take the distributions for inherited IRAs from traditional IRAs that you own. To illustrate this, here’s an example. Sam inherited an IRA from his Aunt Suzy. The RMD amount for the inherited IRA is $6,000. Sam also has his own IRA, for which the RMD amount is $10,000.

Sam cannot combine the two RMD amounts—one from his account, one for the inherited one—and withdraw from only one. Each RMD must be withdrawn from its respective account.

RMDs and Roth IRAs

Note, too, that there are different rules for distributions from Roth IRAs that are inherited. (Roth IRAs don’t have RMDs during the original owner’s lifetime.) As in, distributions may be required. “Roth IRAs for individual participants are not subject to RMDs, but inherited Roth IRAs are,” notes Marguerita M.Cheng, CFP®, RICP, CEO of Blue Ocean Global Wealth, Gaithersburg, Md.

If the Roth is inherited from a spouse, the RMD requirement does not apply. In most cases, with an account you inherit from someone else, you will have to start withdrawing funds—not in specific amounts or on a specific schedule, but you must ensure that the account is emptied within 10 years of the original owner’s death. A few beneficiaries in some special groups—minor children, disabled individuals, heirs less than a decade younger than the deceased—have a few other options, including basing the RMDs on their own life expectancies.

RMDs and 401(k)s

If you have multiple 401(k) plans, the RMDs cannot be taken from just one of those plans. “If you have 401(k) plans from former employers, you would need to take RMDs on those, and, unlike IRAs, you would need to calculate the RMD for each plan and take that amount from each account,” says Fred Leamnson, ChFC, founder, and president of Leamnson Capital Advisory, Reston, Va.

4. Combining RMDs With Your Spouse

Many financial assets may be held jointly by a married couple, but retirement accounts are not among those. These must be owned individually. That individual responsibility also applies to taking RMDs.

Unfortunately, couples often miss this distinction, especially if they file taxes jointly. As they file a single combined tax return, they assume—wrongly—that an RMD taken from one spouse’s retirement account will satisfy the RMD on the other’s account.

Let’s say you and your spouse both face distributions, and you decide to simply take the entire combined amount of those RMDs out of your spouse’s IRA. Taking your RMD from your spouse’s IRA leads to a host of tax consequences, none of them good.

In the eyes of the IRS, you’ve missed taking your RMD. The agency will impose up to a 25% excise tax on that RMD amount. Meanwhile, your spouse will have “overdistributed” by taking more from her account than was necessary, which likely means paying more taxes. That tax can be reduced to 10% if you act quickly to correct the error.

The Bottom Line

After saving for years—or decades—you eventually have to start withdrawing the money in your retirement accounts and pay taxes on it. From 2023 on, you must start taking RMDs at age 73, and that age rises to 75 after 2033. The stakes are high—financially speaking—if you make a mistake.

If you need help figuring out your RMDs, or taking them on time, it’s a good idea to speak with a financial advisor or tax accountant who can help guide you through the process and avoid any mistakes.