Penalty free: steps to help your senior clients avoid RMD penalties.

• Author: Kay Foss, Mary
• Position: Retirement plans

One of the highest penalties imposed by the Internal Revenue Code usually applies to the elderly.

If an individual fails to take out the Required Minimum Distribution (RMD) from a retirement plan, there is a 50 percent penalty on the shortfall. The penalty applies to IRA owners and qualified-plan participants who have reached the required beginning date. It also applies to owners of IRC Sec. 403(b) annuities and beneficiaries of qualified plans, IRAs and Roth IRAs.

[ILLUSTRATION OMITTED]

One piece of good news for 2009: the penalty does not apply this year. However, it must be dealt with on 2008 returns and CPAs must re-educate their clients for 2010. This article gives steps to navigate or, better yet, prevent the penalty.

The Penalizing Details

So how does the IRS administer this penalty? Until 2003, it had very little information about individuals who might be subject to the penalty. Today, IRA custodians report to the IRS the identity of those required to take RMDs. The RMD amount, however, is not reported, and there is no reporting of those required to take distributions as beneficiaries or as participants in qualified plans or IRC Sec. 403 arrangements.

The penalty is reported on Form 5329, which triggers the statute of limitations on penalties. If a taxpayer wants the IRS to waive the penalty, the waiver request must accompany Form 5329.

If it looks like a taxpayer has failed to receive the RMD, there are a number of steps to be taken.

First, recalculate the amount to be withdrawn. Taxpayers with a number of IRAs calculate the RMD for each account, add them and withdraw the amount from any of the IRAs. There is no requirement that distributions be taken pro rata from the IRAs. Similarly, if taxpayers have more than one IRC Sec. 403(b) arrangement, they calculate the RMDs separately, but can withdraw the RMD from any account.

The rules are more complicated if RMDs are due from qualified plans. In these cases, the RMD must be taken from each plan--there's no combining with other qualified plans and no commingling with IRA or IRC See. 403ib: RMDs.

The missed amount is often less than the amount of withdrawal that the taxpayer intended, which is why refiguring the amount is important. When you know the absolute minimum that has not been withdrawn, proceed to step two: subtract the amount actually withdrawn from the minimum you calculated. This is the amount to which the 50 percent penalty applies.

Once you know the potential penalty...