Required Minimum Distributions: Did You Miss Your Required Beginning Date?

Spring 2016Articles For Your Benefit

Last month, the IRS reminded taxpayers who turned 70-½ during 2015 that, in most cases, they need to start receiving a distribution from the IRAs and employer-sponsored retirement plans by April 1, 2016. This mandated distribution is referred to as a “required minimum distribution” or “RMD.”

By way of background, employer-sponsored defined contribution retirement plans, IRAs and individual retirement annuities are subject to the RMD rules. Generally, RMDs must begin by the April 1 following the later of the calendar year in which the individual reaches age 70-½ or retires; however, the required beginning date for 5 percent owners from employer-sponsored retirement plans is April 1 following the year in which the individual reaches 70-½. Typically, the RMD for each year is determined by dividing the account balance as of the end of the prior year by a distribution period prescribed by uniform tables in IRS regulations.

Failure to take the RMD triggers a 50 percent excise tax, payable by the plan participant or IRA owner or, if deceased, the beneficiary. In some cases, the tax may be waived by the IRS, if the distribution occurred because of reasonable error and if reasonable steps are taken to remedy the violation. The failure of a qualified plan sponsor to make a RMD could also threaten the tax-qualified status of the retirement plan.

Individuals

If you are an individual who turned 70-½ in 2015 and did not take your RMD, you are subject to an excise tax of 50 percent on the underpayment under Internal Revenue Code Section 4974. This amount is supposed to be added to your individual income taxes due for the year in which the distribution is required. Luckily, all is not lost because you can request a waiver of the 50 percent excise tax by filing Form 5329 with the IRS. While the IRS does not grant a waiver in all circumstances, it retains significant flexibility to waive the excise tax when the facts and circumstances support it (i.e., when there is “reasonable cause”).

As a practical matter, and before filing the Form 5329, it is advisable that you take immediate action by withdrawing the RMD as soon as possible. Next, in order to avoid paying the 50 percent excise, you should complete Form 5329 and attach a brief explanation stating why you failed to take the RMD and that you have already taken steps to correct it by requesting and, hopefully, receiving the appropriate distribution. Following submission, the IRS will review the information provided and decide whether to grant the request for the waiver.

Employers

As noted above, the RMD rules are qualification requirement applicable to employer-sponsored defined contribution plans, meaning they must be written into the plan document. Failing to follow the terms of the plan document can result in the loss of the plan’s tax qualified status (in addition to the individual penalties levied against the participant).

The IRS, through the Employee Plans Compliance Resolution System (EPCRS), offers employers an opportunity to correct this qualification failure through either its Self-Correction Program (SCP) or its Voluntary Correction Program (VCP). SCP allows an employer to self-correct the RMD errors so long as the violations are corrected within the two plan years following the plan year in which the violations occur. In such a case, an employer will not need to submit a formal application to the IRS and, instead, will fully correct the failure by making all of the missed RMDs and adopting procedures to ensure the failure does not occur again. When the failures have occurred beyond the time available for SCP, a plan sponsor should correct the failures through VCP.

Under VCP, a plan sponsor submits a formal application to the IRS that, generally, identifies the failures, describes the corrective actions taken (i.e., shows that the RMDs have been made) and outlines the procedures adopted to ensure that the failures do not occur again. There is a fee associated with submitting an application to the IRS under VCP that is typically based on the number of participants in the plan. However, in circumstances where the only failure identified in the VCP application is the missed RMDs, a reduced fee is available depending on the number of participants affected ($500 if 150 or fewer participants are affected; $1,500 if 151 to 300 participants are affected). Additionally, and unlike SCP, submitting through VCP allows an employer to request the waiver of any excise tax associated with the missed RMDs. Therefore, in addition to preserving the tax-qualified status of the plan, the employer is able to request waiver of the additional taxes that are otherwise paid by the participant who failed to take the RMD.

While RMD failures are not uncommon, it is important that plan sponsors take appropriate steps to monitor the age of all participants who are approaching age 70 to avoid making this otherwise preventable mistake. Fortunately, even when an error has occurred, the correction programs made available by the IRS allow employers to resolve these issues in a manner that both protects the underlying plan and eliminates the excise tax imposed on affected participants and beneficiaries.