Is It Ever Better to Pay the RMD Penalty Than Take the Distribution?

The scenario

You're a wealthy retiree with a large IRA, significant taxable investment income, and you don't need the Required Minimum Distribution money. Your combined federal and state marginal tax rate approaches 50%. Taking the RMD adds taxable income you don't want, triggers IRMAA surcharges, and pushes more of your Social Security into the 85% taxable range.

The RMD penalty for failure to withdraw is 25% of the amount you should have taken (reduced from 50% under SECURE 2.0, effective 2023). If you correct the missed RMD within two years, the penalty drops to 10%. So: is paying a 25% penalty cheaper than paying 50% in taxes?

The math that makes it look appealing

Setup: IRA balance of $2,000,000. Age 75. Under the 2026 Uniform Lifetime Table, the divisor for age 75 is 25.6. Required distribution: $2,000,000 / 25.6 = $78,125.

Option A — take the RMD:

• $78,125 added to taxable income
• Federal tax at 37%: $28,906
• California tax at 12.3%: $9,609
• IRMAA surcharge triggered: $4,884/year (pushed into higher tier)
• Additional SS taxation: ~$2,200 (more SS becomes taxable)
• Total cost: ~$45,599, or 58.4% of the RMD

Option B — skip the RMD and pay the penalty:

• 25% penalty on $78,125: $19,531
• IRA balance remains invested, grows tax-deferred
• No IRMAA trigger, no SS taxation increase
• Total cost: $19,531, or 25% of the RMD

The penalty appears to save $26,068. Over 10 years of skipped RMDs, that could be $200,000+ in savings. The strategy looks like a no-brainer.

Why it doesn't actually work

Problem 1: the penalty doesn't replace the tax

The 25% excise tax is a penalty for not taking the distribution. It is not a tax on the distribution itself. You still owe income tax on the money when you eventually withdraw it — whether voluntarily or upon death and inheritance.

The penalty is an additional cost, not a substitute for income tax. The correct comparison is:

• Take RMD now: pay ~$38,500 in income tax (federal + state), plus secondary effects (IRMAA, SS)
• Skip RMD: pay $19,531 penalty now, plus ~$38,500 in income tax later when the money eventually comes out

The only savings from skipping is the time value of deferring the income tax — not the income tax itself.

Problem 2: the deferred balance grows, creating larger future RMDs

By not taking the $78,125 RMD, that money stays in the IRA and continues growing. At 7% annual growth:

• Year 1 skipped RMD: $78,125 grows to $83,594 by next year
• Next year's RMD is calculated on the larger balance
• The IRA balance compounds faster than if you'd withdrawn the RMD

Over 10 years of skipping, the IRA balance could be $400,000-$600,000 larger than if you'd taken RMDs. When the money eventually comes out (during your lifetime, or as inherited IRA distributions to beneficiaries within the 10-year rule), the tax bill on that accumulated excess is substantial.

Problem 3: inherited IRA acceleration under SECURE Act

Under the SECURE Act (2019) and SECURE 2.0 (2022), most non-spouse beneficiaries must empty an inherited IRA within 10 years. If your strategy is to let the IRA grow by skipping RMDs and leave it to heirs in "lower tax brackets," those heirs are forced to distribute the entire balance within a decade — potentially during their peak earning years.

A $2,000,000 IRA that grows to $3,500,000 by the time it's inherited must be fully distributed within 10 years. That's $350,000/year in additional ordinary income for the beneficiary — pushing them into the 35-37% bracket regardless of their normal income level.

Problem 4: the IRS notices

The IRS receives Form 5498 from your IRA custodian every year, reporting your year-end IRA balance. They also know your age. Missing an RMD is one of the most easily detected tax compliance failures.

Under SECURE 2.0, the statute of limitations for the RMD penalty is 3 years from the date the return was filed (or 6 years if you didn't report the penalty). The IRS can and does assess these penalties years after the fact.

When the penalty math gets closer

There is a narrow scenario where the arithmetic is less clear-cut:

Terminal illness with estate planning: if you have a short remaining life expectancy, skipping RMDs for 2-3 years and paying the 25% penalty could make sense if your beneficiaries are in significantly lower tax brackets than you. The penalty (25%) plus the beneficiary's tax rate (say, 22%) totals 47% — comparable to your 50% rate.

But this requires:

• Beneficiaries actually being in lower brackets when they receive the inherited IRA
• The 10-year distribution rule not pushing them into higher brackets
• The total IRA balance being small enough that annual distributions don't spike the beneficiary's income

In practice, this scenario is rare and difficult to predict with confidence.

The better strategies for high-income retirees

Instead of skipping RMDs, consider these approaches:

Qualified Charitable Distributions (QCDs)

If you're 70½ or older, you can direct up to $111,000/year (2026, indexed) from your IRA directly to qualified charities. QCDs satisfy your RMD requirement and are excluded from taxable income entirely.

For a retiree who would donate to charity anyway, QCDs are strictly better than taking the RMD, paying tax, and then donating from after-tax funds. The QCD eliminates federal tax, state tax, IRMAA impact, and SS taxation effects — all at once.

Roth conversions before RMDs begin

The optimal window for Roth conversions is between retirement and the RMD start age — age 73 for those born 1951–1959, and age 75 for those born in 1960 or later. During these years, your income may be lower — especially if you delay Social Security.

Converting $100,000-$200,000/year in the 22-24% brackets before RMDs force you into the 35-37% brackets can save hundreds of thousands over a lifetime. The conversion tax is a one-time cost; the RMD tax would have been recurring and growing.

Taking RMDs in-kind

Instead of selling investments to fund the RMD, transfer shares directly from the IRA to a taxable brokerage account. You still owe income tax on the FMV of the transferred shares, but this avoids selling at an inopportune time and resets the cost basis to current FMV.

Net Unrealized Appreciation (NUA)

NUA treatment can convert the appreciation on employer stock from ordinary income rates to long-term capital gains rates. Critically, NUA must be elected at the point of distribution directly from the employer 401(k) plan, as part of a qualifying lump-sum distribution — you take the employer stock in-kind into a taxable account while rolling the rest of the plan over. NUA is generally lost once the employer stock has been rolled into an IRA. If you still hold appreciated employer stock inside a 401(k), this is a complex but valuable strategy to evaluate before you roll the plan over; if the stock is already in an IRA, NUA is no longer available.

Worked example: penalty vs. QCD vs. Roth conversion

Profile: age 75, $2M IRA, $78,125 RMD, 37% federal + 12.3% CA = 49.3% combined rate, donates $50,000/year to charity.

The QCD strategy saves $29,533/year compared to taking the full RMD and paying tax — without any penalties or IRS risk. And early Roth conversions would have eliminated the problem entirely.

The bottom line

Paying the 25% RMD penalty is almost never better than taking the distribution, because the penalty doesn't replace the income tax — it's an additional cost on top of the eventual tax. The money must come out of the IRA eventually, and it will be taxed when it does. Better strategies include QCDs for charitable givers, pre-RMD Roth conversions, and careful income management to minimize the effective rate on distributions.