Thursday, March 31, 2016

Correcting missed required minimum distributions

Federal tax law requires every qualified plan to provide required minimum distributions (RMDs) as soon as a participant reaches his or her required beginning date (RBD). Generally, the RBD is April 1 of the year after the participant reaches age 70½, though it may be later if the participant owns 5% or less of the employer and continues to work for the employer beyond age 70½.

If an individual worked at seven jobs during his or her career and left money in seven different qualified plans, each plan is required to distribute an RMD to the individual. In the event of a participant’s death, the plan is required to follow the minimum distribution requirements for beneficiaries.

Failure to distribute an RMD may result in plan disqualification and/or the imposition of a 50% excise tax on the participant or beneficiary. This article explains the correction process that is available when a qualified plan fails to timely distribute an RMD.

Missed RMDs from qualified plans
Mistakes can result in one or more missed RMDs. For example, an employee’s date of birth may be incorrectly provided to the recordkeeper or third party administrator, inadvertently causing the employer and plan administrator to be unaware of the year that the employee attained age 70½. Or, an employee’s data may have been lost in a merger or acquisition.

Upon discovery of a missed RMD, all appropriate steps should be taken to remedy the situation as soon as possible. Specifically, the RMD should be immediately distributed along with calculated earnings. If the employer files under the IRS’s Voluntary Correction Program (VCP), the employer may request that the IRS waive the excise tax imposed on the missed RMD.

Excise tax
As noted, a participant or beneficiary who does not receive a full RMD for a distribution calendar year is subject to a federal excise tax of 50% of the underpayment. For example, assume an RMD is $3,200 for 2015, but the participant received only $2,000. The underpayment of $1,200 is subject to the 50% excise tax of $600. The $1,200 still has to be withdrawn. The participant files IRS Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, with his or her federal income-tax return for the year in which the error occurred.

Waiver of the 50% penalty due to reasonable cause
If the employer does not request waiver of the excise tax under VCP, the participant or beneficiary may be granted a waiver for the excise tax when they file Form 5329 if there was a reasonable cause for the failure to take the RMD and steps are taken to remedy the shortfall. The IRS will review the information provided and decide whether to grant the request for the waiver.

Automatic waiver for certain beneficiaries
An automatic waiver may be available in situations where the participant dies before reaching his or her RBD and an individual is the sole beneficiary of a participant’s benefit or of a separate share of the participant’s benefit. If the amounts are payable under the life expectancy method and a payment is missed during the first five years, the excise taxes are waived if the total death benefit or separate share is paid under the five-year rule.

Correcting RMD failures using the Employee Plans Compliance Resolution System (EPCRS)
The EPCRS provides a streamlined procedure for correcting missed RMDs under the VCP using Form 14568-H, Appendix C Part II Schedule 8, Failure to Pay Required Minimum Distributions Timely under §401(a)(9). As part of the VCP submission, the employer is able to request the waiver of the participant level excise tax imposed under IRC Sec. 4974.

Fee schedule for RMD failures
IRS Revenue Procedure 2015-27 recently updated the VCP fee for missed RMDs, amending it to $500 for missed RMDs involving 150 or fewer participants. The compliance fee is $1,500 when 151 to 300 participants are involved. If more than 300 participants failed to receive RMDs, the IRS’s general fee schedule, which is based on the number of participants in the plan, will be used.

Correction includes distribution of missed RMDs plus earnings
In a defined contribution plan, the permitted correction method under EPCRS is to distribute the missed RMDs with earnings from the date of the failure to the date of the distribution. If more than one year’s RMD has been missed, the amount required to be distributed is the RMD for each year, starting with the year in which the initial failure occurred. Amounts are determined by dividing the adjusted account balance on the applicable valuation date by the applicable distribution period and then calculating the earnings for each missed RMD.

Example: A defined contribution plan missed a participant’s RMDs for 2013, 2014, and 2015. The participant was born in 1941.

The missed RMD for 2013 would be calculated as follows:

  • December 31, 2012, fair market value (FMV) $100,000 ÷ 25.6 (age 72) = $3,906.25*

The missed RMD for 2014 would be calculated as follows:

  • December 31, 2013, FMV $108,000 – $3,906.25 ÷ 24.7 (age 73) = $4,214.32*

The missed RMD for 2015 would be calculated as follows:

  • December 31, 2014, FMV $115,000 – $3,906.25 – $4,214.32 ÷ 23.8 (age 74) = $4,490.73*

*Gains/losses are calculated on each RMD from the date the RMD should have been distributed until the actual distribution date.

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