For senior citizens age 70 1/2 or older who have not yet taken the annual required minimum distribution from their IRAs, time is running out.
If seniors unknowingly miss the Dec. 31 deadline, it ends up costing them dearly in the form of a tax penalty that amounts to 50 percent of what they should have withdrawn.
One of the largest financial services firms in the world, Fidelity Investments, based in Boston, reported that as of Nov. 27, the majority — nearly 60 percent — of the company’s more than 800,000 IRA customers who are supposed to take required minimum distributions for the tax year 2014 had yet to take the full amount from their Fidelity IRAs.
“We watch the number weekly throughout the year, and we see it decline as it gets closer to the end of December, but we have concerns when we see a large number of customers who have taken nothing or have not finished taking their required distributions,” said Maura Cassidy, director of retirement products at Fidelity.
That may not be a complete picture, of course. Some customers may be taking their required minimum distributions from other IRAs they own. “They may be satisfying their requirements at their other IRA provider and we would have no way of tracking that,” Cassidy said.
The required minimum distribution rule was put in place to make sure IRA and 401(k) account owners pay their fair share of taxes on retirement savings during their lifetime, rather than hoarding the money, delaying taxation indefinitely and leaving it to heirs.
Owners of Roth IRAs do not have to make required withdrawals. They also owe no taxes on their withdrawals because all contributions to the account have already been taxed and the interest is allowed to grow tax-free.
The Internal Revenue Service has established a uniform lifetime table to determine what percentage of the account must be withdrawn at different ages. For instance, if the IRA account balance is $100,000 and the account owner is 70 with a birthday before June 30, that person would need to withdraw at least $3,649.64.
The IRS has another distribution table for beneficiaries of retirement funds and account owners who have much younger spouses.
Alex Kindler, a partner at the Pittsburgh accounting firm Horovitz Rudoy & Roteman, said although in past years, the firm has seen several clients who forgot to take their required minimum distribution, it is becoming less common.
“The plan administrators, particularly from the larger brokerage houses, tend to be more proactive in reminding their customers,” Kindler said. “One recommendation we typically make to clients is that they sign up for automatic withdrawal of the required minimum distribution from specific accounts.”
Still, there are a couple of other mistakes that people can make, he said.
The rules are slightly different for traditional IRAs versus 401(k)s. For 401(k)s, investors must calculate the required minimum distribution for each account and make separate withdrawals from each. But investors can total all IRA account balances and take the required minimum distribution from one account.
“People get the rules confused,” Kindler said. “They think they can make one withdrawal from a 401(k) to satisfy the requirement, but end up falling short of the rules, making them subject to a very onerous 50 percent penalty,” he said.
If an investor failed to make a required $5,000 minimum withdrawal, the IRS would levy a penalty of 50 percent or $2,500. After deducting another $750 for taxes at a 15 percent tax rate, the investor who should have withdrawn $5,000 would be left with only $1,750 after sending a check for $3,250 to the federal government.
The IRS often does allow some forgiveness, according to Cassidy.
“We find with most customers, if they take out the amount they missed as soon as possible and apply to the IRS for an exception to the penalty, the IRS often waives the penalty,” she said.