Background
Individual Retirement Accounts (IRAs), tax sheltered annuities under Code §403(b), Eligible Deferred Compensation plans under Code §457(b) and qualified plans under Code §401(a) generally must provide for the payment of benefits to plan participants not later than the participants required beginning date. Roth IRAs are not subject to the minimum distribution rules during the lifetime of the accountholder but are subject to the distribution after death rules. Code §401(a)(9) provides specific rules with respect to the timing and determination of minimum payments. The rules are intended to prohibit a participant from deferring the commencement date for the payment of benefits in order to pass all such tax-advantaged accumulations to his or her beneficiary(s). However, a participant is still afforded the opportunity to provide for the continuation of benefit payments to his or her spouse or other named beneficiary.

On April 17, 2002 the Internal Revenue Service finalized the regulations covering required minimum distributions. The new regulations supersede the 1987 and 2001 proposed regulations that accountholders and plan sponsors were operating under. One of the significant changes in the finalized regulations is the issuance of updated life expectancy tables to be used in the calculations of the distributable amount.

The finalized regulations apply to all types of defined contribution plans and were required to be used for 2003 and thereafter.

Required Beginning Date (RBD) : The RBD is the deadline for RMDs to begin.

April 1st after the year that age 70½ is attained for:

• 5% owners (defined as someone who owns more than 5% of the business; family attribution rules apply).
• Employees who are not 5% owners and who retire before or during the year they reach age 70½.
• Owners of individual retirement accounts.

April 1st after the year in which retirement after age 70½ for:

• Employees who are not 5% owners who continue to work for the employer sponsoring the plan beyond the year in which they reach age 70½, provided the plan document contains this provision.

Click here for an article on RBD.

Determination of Annual Minimum Required Distribution

Divide account balance as of the beginning of the plan year by life expectancy determined from the uniform lifetime table based on the participant's highest attained age in the distribution calendar year. The distribution calendar year is the year for which a minimum distribution must be paid.

Note: If the participant is married and his or her spouse is more than 10 years younger, the joint life expectancy table is used to determine the applicable divisor in the RMD calculation.

Highest Attained Age Example: An accountholder turns 70½ on April 23, 2007. The highest attained age (or actual birthday) in 2007 is 71. Use 71 from the table.

Account Balance. The actual balance on the last valuation day in the prior year is used. Contributions made after the valuation date but attributable to the prior year are no longer required to be included in the account balance. In addition, if the initial distribution is delayed until April 1st of the following year, it is no longer required to be excluded from the account balance.

If the plan contains after-tax contributions, the calculation includes these amounts and they can be used to satisfy the required minimum distribution amount.

If a participant is not fully vested in his or her account balance, then the calculation is based on the entire account but the payout can only go up to the vested portion. The payout for the subsequent distribution calendar year must be increased by the sum of the amounts not distributed in prior calendar years because the employee’s vested benefit was less than the required minimum distribution. Most participants are fully vested by their required beginning date, but if the employee is new to the company, this rule may be applicable.

Example Factset:
»  Determination of required distribution if first distribution calendar year is 2007.
»  Participant's highest attained age in the first distribution calendar year (2007) is 71.
»  Account balance as of December 31, 2006 is $500,000.
»  The beneficiary is the same age as the participant.
»  A contribution of $10,000 was made on March 15, 2007 attributable to the 2006 plan year.
»  Plan's rate of return for payout period is 10%.
»  Installment payments are made at the end of the plan year.

MHC Comment. The minimum distribution can be made at any time during the applicable year and multiple payments are acceptable.

First Distribution

Value at beginning of first year             $500,000

Life expectancy in first year                     ÷ 26.5

First Distribution (made 12/31/06) =        $18,868

 

Second Distribution

Value at beginning of first year 12/31/06: $500,000

Increase in account in 2007:                     $60,000

First Distribution                                      - 18,868

Value at beginning of second year            $541,132

Life expectancy in second year                    ÷ 25.6

Second distribution =                               $ 21,138

MHC Comment. These are minimum distributions. The participant could request higher payments. However, distributions in excess of the minimum cannot be carried over to satisfy the minimum distribution in a future year.

Click here for article on off-calendar-year plan RMD calculations.

The Significance of Not Paying a Required Minimum Distribution from a Qualified Plan

Qualification requirement. All qualified plans, such as profit sharing, 401(k), and money purchase, must meet the requirements of Internal Revenue Code Section 401(a). There are over 30 requirements in §401(a). For example, the plan must be established and maintained for the exclusive benefit of the employees and their beneficiaries, contributions or benefits under the plan must not discriminate in favor of highly compensated employees, and the plan must satisfy minimum coverage requirements and vesting standards. Failure to comply with any of the plan’s qualification provisions found in §401(a) can cause the plan to be disqualified by the IRS.

RMD Rules for Qualified Plans. Code §401(a)(9) requires every qualified plan to provide required minimum distributions (RMDs) as soon as a participant reaches his or her required beginning date (RBD), generally age 70½ or possibly later if a non owner continues to work until a later age. The participant’s earlier death will also cause the payment of minimum distributions. So, if an individual worked at seven jobs during his career and leaves money in each 401(k) plan until reaching age 70½, then each plan is required to distribute an RMD amount to the individual.

Different Rules for IRAs. The rules governing required minimum distributions from individual retirement accounts (IRAs) are different from the ones that apply to qualified plans in one important way: IRA RMDs may be aggregated. If an individual has traditional IRAs with ten different financial institutions, when RMDs are due (at age 70½ and thereafter), he can calculate the RMD amount for each IRA, add the ten RMD amounts together, and take the aggregate RMD distribution amount from just one IRA (or more, if he wishes). The IRA RMDs may not be combined with the qualified plan RMDs. Often individuals think the IRA rules apply to qualified plans. They do not.

Missed RMDs from Qualified Plans. If an RMD is not distributed from an employer’s qualified plan, then the plan fails to satisfy one of the §401(a) qualification requirements and could be subject to disqualification, especially if there is an IRS audit that uncovers a disregard of the §401(a)(9) RMD requirements.

However, mistakes can happen. For example, an employee’s date of birth may be incorrect, inadvertently causing the employer and plan administrator to be unaware of the year that the employee attained age 70½. Upon discovery of such an error, all appropriate steps should be taken to remedy the situation as soon as possible. Specifically, RMDs should be calculated for all years since the participant attained age 70½ and ─ to the extent they were not distributed ─ they should be immediately distributed. If the employer files under the IRS Voluntary Compliance Program (VCP), the IRS will waive the 50% excise tax on missed RMDs.

Missing RMDs must be a frequent audit issue because the IRS added a correction procedure for missed RMDs to its Employee Plan Compliance Resolution System (EPCRS) in Revenue Procedure 2006-27.

Fee Schedule for RMD Failures. Normally, the IRS filing fee is based on the number of participants in the plan. But a new fee schedule applies to plan failures involving the RMD rules in §401(a)(9). The fee for a missed RMD filing is much lower than the regular IRS schedule. If 50 or fewer participants are affected by the failure, the penalty is $500, regardless of the actual number of plan participants. In addition to simplifying and encouraging the correction process, this enhancement sets a clear benchmark in an area of plan administration that is likely to happen at one time or another.

It is important to make sure that each individual in a qualified plan who has reached his or her required beginning date begins taking required minimum distributions.The RMD may be done in annual installments even if the document does not otherwise provide for installment payments because the RMD requirements must be met for the plan to be qualified. Thus, a plan document may permit RMD amounts to be taken each year (even if lump sum is the only distribution method in the document) .

Bill Grossman, QPA