Retirees Lose Up to $1.7B Annually to IRS Penalties for Making This Year-End Mistake

US retirees face IRS penalties of up to 25% if they do not start taking required minimum distributions (RMDs) from their pretax investment accounts at age 73. The first RMD must be taken by 1st April of the year after turning 73, with subsequent withdrawals due by 31st December each year. If you do not withdraw the full RMD by the annual deadline, the IRS imposes a penalty amounting to 25% of the amount that should have been withdrawn.

RMDs are calculated based on your account balance, your age, and an IRS life expectancy factor. The year-end RMD deadline also applies to heirs, such as non-spouse beneficiaries. For example, adult children who have inherited IRAs must begin annual withdrawals in 2025 if the original IRA owner reached RMD age before passing away. Since 2020, certain heirs are required to deplete inherited IRAs within 10 years.

'Missed RMDs are a billion-dollar mistake,' said Vanguard's Aaron Goodman in a December report, which revealed that 6.7% of Vanguard clients of RMD age missed their annual withdrawals in 2024. Among these investors, the average RMD was $11,600 (£8,639), which could have incurred a maximum penalty of 25%, or $2,900 (£2,159). Vanguard estimates there are approximately 8.7 million IRA owners at RMD age, and with 6.7% or around 580,000 individuals missing their RMDs, the collective penalties could amount to up to $1.7 billion (£1.2 billion) annually.

Missed Withdrawals Are Sticky

The Vanguard report highlights that behaviour around RMDs tends to be consistent year after year. It is estimated that 55% of those who miss an RMD in one year also miss it in the following year. 'Most investors seem to make RMDs a routine, but rather than "set and forget", many simply "forget and forget",' said Vanguard's Andy Reed.

Missed RMDs are most prevalent among investors with lower account balances. Vanguard estimates that 56.8% of investors with balances under $5,000 (£3,723) missed their RMDs in 2024, compared to only 2.5% of those with balances over $1 million (£744,750). Additionally, self-directed investors are three times more likely to miss RMDs than those advised by financial professionals.

'Missed RMDs are more common for some investors and more costly for others,' Goodman added.

How To Avoid IRS Penalty on RMDs

While missing an RMD can result in a 25% penalty, this can be reduced to 10% if the withdrawal is 'timely corrected' within two years and Form 5329 is submitted. The IRS may even waive the penalty entirely if your shortfall was due to 'reasonable error' and you have taken 'reasonable steps' to rectify the mistake.

Fidelity's Sham Ganglani recommends taking your RMD as early as possible if you have missed the deadline, as the IRS is generally willing to work with individuals who are doing the right thing. The Vanguard report also suggests using auto-RMD services to ensure timely withdrawals. Consolidating smaller accounts can also make it easier to remember to take RMDs from multiple 'small pots'.

'With investors changing jobs nine times or more during their working lives, it's tough to keep track of all retirement accounts,' said Goodman. 'Combining IRAs and setting RMDs on autopilot removes the risk of forgetting.'

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