Massachusetts Life Producer Practice Exam

What must a participant do to avoid the excise tax for not taking minimum distributions?

1. Take annual distributions based on need

2. Withdraw the full amount from the plan

3. Take required minimum distributions annually

4. Convert the account to a taxable account

The correct answer is: Take required minimum distributions annually

To avoid the excise tax for not taking minimum distributions, a participant must take required minimum distributions (RMDs) annually. This requirement is established by the Internal Revenue Service (IRS) to ensure that individuals with retirement accounts begin to withdraw funds from these accounts, as they provide tax-deferred growth. RMDs must start by a certain age, and the amounts are calculated based on the account balance and the participant's life expectancy. Failing to withdraw the required minimum distribution not only means that the individual may lose out on necessary retirement funds, but it also subjects them to a steep excise tax—specifically, a penalty of 50% of the amount that should have been withdrawn but wasn't. Therefore, regularly taking RMDs is crucial for compliance with tax regulations and for avoiding unnecessary tax penalties associated with retirement account distributions.