RMDs: The 3-Year Statute of Limitations

RMDs: The 3-Year Statute of Limitations

October 13, 2023

If you're approaching retirement, you might be familiar with Required Minimum Distributions (RMDs). However, the rules surrounding RMDs are changing, and without proper planning, you could risk IRS-enforced collections. Here's what you need to know. 

The SECURE 2.0 Act of 2022, enacted Dec. 29, includes almost 100 new retirement plan provisions, many of which aren’t effective yet. But some big changes involving required minimum distributions and related penalty relief are already in effect

Before we delve into the 3-year statute of limitations, let's briefly recap what RMDs are and why they matter.

What are RMDs?

A required minimum distribution (RMD) is the amount of money that must be withdrawn from employer-sponsored retirement plans by owners and qualified retirement plan participants of retirement age.

In 2023, the age at which you must begin taking RMDs changed to 73 years. Account holders must, therefore, start withdrawing from a retirement account by April 1, following the year they reach age 73. The exact age may vary depending on your retirement plan and when you were born.

The IRS uses a specific formula to calculate your RMD, considering your account balance and factors related to life expectancy. In 2023, the RMD table is based on the IRS's widely-used Uniform Lifetime Table. It's worth noting that the IRS has additional tables for account holders and beneficiaries whose spouses are considerably younger.

SECURE 2.0 Shakes Things Up for RMDs

The Securing a Strong Retirement Act of 2022, known as SECURE 2.0 Actmade some changes to the rules about when and how people need to take out money from their retirement plans to avoid being hit with extra taxes.

These changes were designed to make things easier for retirees by giving them more time to file, removing certain requirements, and lowering penalties if they make a mistake. Some of these updates are already in place, and others will start in the coming years, with the last ones kicking in by 2033. The main changes to RMDs include:

1. Changes to the Participant’s RMD Age (Effective in 2023)

Under the SECURE Act of 2019, the RMD age for a terminated participant increased from 70½ to 72 effective in 2020. SECURE 2.0 again changes the RMD age to 73 in 2023, and ultimately to age 75. The chart below highlights the changes to the RMD age at relevant points in time.

2. No RMDs Required from Roth Accounts (Effective in 2024)

For 2024 and later years, RMDs are no longer required from designated Roth accounts. You must still take RMDs from designated Roth accounts for 2023, including those with a required beginning date of April 1, 2024. You can withdraw more than the minimum required amount.

3. Removing RMD Barriers to Life Annuities

The rules for Required Minimum Distributions are designed to prevent individuals from deferring taxes for too long, and one way they achieve this is by limiting annuity contracts from providing small initial payments that grow excessively over time. However, in practice, these rules can sometimes restrict even minor increases in benefits. But now, Congress is working to make annuity contracts in defined contribution plans more appealing.

Section 201 of the Act allows commercial annuities purchased under 401(k) and other defined contribution plans, as well as IRAs, to offer the following:

  1. Increases in payments of up to 5% per year.
  2. The option to receive certain lump sums that replace future distribution payments.
  3. The ability to accelerate up to 12 months' worth of payments.
  4. Reasonable dividend payments.
  5. Death benefits that are equal to the cost of the annuity, reduced by previous payments.

4. Reduction in Excise Tax for RMD Errors

Despite regularly appearing on the list of priorities for tax-exempt and government entities' compliance, it's not unusual for people to make mistakes when it comes to Required Minimum Distributions (RMDs). 

Up to now, one of the largest penalties in the Tax Code was the 50% penalty for not taking an RMD. It was based on the RMD amount that should have been taken but wasn’t. 

SECURE 2.0 lowers this penalty to 25%, and then to 10% if the missed RMD is timely made up.

What is the Statue of Limitations?

The statute of limitations is the time limit for the IRS to file charges or collect back taxes. In general, a statute of limitations is a law (statute) that limits how far back you can go when assessing a penalty, charging someone with a crime, or taking other actions. There are different statutes of limitations for different types of tax issues.

RMDs and the 3-Year Statute of Limitations

There is now a three-year statute of limitations associated with the failure to take a required minimum distribution (RMD) from a retirement account. Overlooked when the SECURE Act 2.0 was enacted was Section 313 of the Act, which added a 3-year statute of limitation for the failure to take an RMD. If an RMD is missed, the 25% penalty is only applicable for the next three years. So what happens after those three years have passed?

The statutes of limitations not only limits the IRS in assessing additional tax on returns filed, but it also limits the amount of time you have to claim a refund or credit due. If the three-year deadline for filing has passed, the IRS, by law, cannot issue your refund.

IRS Form 5329 is a tax form used for reporting retirement plan penalties and requesting a waiver of the RMD penalty. As mentioned above, in the past, not filling out this form for penalty relief meant that the three-year statute of limitations wouldn't start, resulting in a hefty 50% excise tax. However, thanks to the SECURE 2.0 Act, this tax has been reduced to 25%, and it could drop to 10% if you take action to withdraw the missed RMD within two years.

To solve this problem, the SECURE 2.0 Act introduced a statute of limitations tied to when individual files their federal income tax return, Form 1040. If no federal income tax return is required, the statute period begins on what would have been the tax filing deadline. This new statute of limitations covers missed RMDs for three years and excess IRA contributions for six years but doesn't apply to early distributions.

Form 5329 left the statute of limitations open indefinitely, allowing penalties and interest to accumulate unnoticed. A positive outcome happened once Congress addressed the issue. However, even with these changes, there are still exceptions retirees should make note of. 

Exceptions to the Rule

While the 3-year statute of limitations relieves many retirees, it's essential to be aware of exceptions. Not all missed RMDs qualify for this extended correction period. Here are some important exceptions:

  1. Extended Statute for Excess IRA Contributions: The SECURE 2.0 Act extends the statute of limitations to 6 years for the 6% excess IRA contribution penalty. However, this relief is unavailable if an IRA has acquired property below its fair market value, and the statute of limitations remains indefinite if Form 5329 isn't filed.
  2. Expansion of IRS Self-Correction Program: SECURE 2.0 broadens the IRS self-correction program, known as the Employee Plans Compliance Resolution System (EPCRS), to include inadvertent individual retirement account errors, including a waiver for failure to take RMDs. Note that self-correction for IRAs under EPCRS may not be available for two years, as SECURE 2.0 grants the IRS that timeframe to guide this matter.
  3. Elimination of RMDs for Roth 401(k)s: SECURE 2.0 brings welcome relief by eliminating required minimum distributions (RMDs) for Roth 401(k)s and other employer Roth plans. While Roth IRAs were never subject to lifetime RMDs, Roth 401(k)s were. Starting in 2024, individuals will not need to roll over Roth 401(k) funds to a Roth IRA to avoid RMDs, as these funds will be exempt from RMDs.

Working With a Fiduciary Advisor

It’s important to understand how the recent law changes affect your IRA. One of the more relevant topics IRA owners should be aware of is a Required Minimum Distribution (RMD). Partnering with a trusted Fiduciary Advisor can play a crucial role in helping you manage your RMDs effectively so you meet your legal obligations while optimizing your financial situation. They can also offer tailored guidance to help maximize your retirement savings while following IRS rules.

You don't have to battle the confusing regulations for certain required minimum distributions alone. From advice on understanding your specific RMD obligations, to helping you explore tax-efficient ways to manage your RMDs, Agemy Financial Strategies works alongside you to assess your retirement income needs and create a plan for your unique needs and goals. 

Final Thoughts

This 3-year statute of limitations provision is yet one more reason why we anxiously await proposed Regulations from the IRS with respect to how the SECURE Act 2.0 will be interpreted. There are several other provisions in the Act that need a lot of clarification. A solid understanding of Required Minimum Distributions is essential for anyone with tax-advantaged retirement accounts. Failing to comply with RMD rules can result in costly penalties, potentially derailing your retirement plans. 

By staying informed about when RMDs apply, how they’re calculated, and your options for managing them, you can confidently navigate this aspect of retirement planning. If you're ready to take the first step to achieving your retirement goals, our team is here to assist you. The better you comprehend your financial strategy, the more effectively you can manage your finances.

For a detailed list of our service offerings, see here.

Set up your complimentary retirement strategy session today.