LOL... ROFL… BRB… With the advent of social media, there has been a proliferation of new acronyms making their way into our everyday language. Even those who are not social media savvy may likely recognize some of these popular acronyms: LOL - Laughing Out Loud; ROFL – Rolling On Floor Laughing; BRB – Be Right Back. Similar to the world of social media, there are many acronyms pertaining to employee benefit plans (EBP). This edition explores several EBP acronyms we believe would be beneficial for plan sponsors to understand.
RMD is short for Required Minimum Distributions. The Internal Revenue Service (IRS) does not allow retirement funds to be kept tax free indefinitely. At age 70½ participants are required to withdraw a minimum amount from their Individual Retirement Account (IRA), Simplified Employee Pension (SEP) IRA, SIMPLE IRA (Savings Incentive Match Plan for Employees), or retirement plan account (with some exceptions for Roth IRAs).
These distributions are not generally tax free nor can taxes be avoided by rolling the RMD into another tax deferred account. The account owner is taxed at their regular income tax rate on the amount of the RMD withdrawn. Depending on the dollar amount of the RMD, no tax withholdings may be deducted from the amount distributed; however, the taxes would then need to be trued up on the account owner’s annual federal tax return.
Sponsors of retirement plans (including 401(k), 403(b) and defined benefit pension plans) are required to ensure that RMDs occur timely. Despite the fact that a participant may be receiving RMDs, the sponsor is required to continue to make contributions on behalf of that participant (in accordance with the plan document) as well as allow the participant to continue to make salary deferrals, if appropriate.
For a participant’s first RMD, the RMD may be delayed until April 1st of the year after the participant turns age 70½. For all subsequent years (including the year in which the participant first receives an RMD which was delayed to April 1st), RMDs must be made by December 31st. RMDs may also be delayed for participants who are still employed (although generally not available to employees who are deemed to be a 5% owner and certain relatives of such an owner) as well as for older 403(b) accounts (generally pre-1987 accounts).
Required minimum distribution rules also apply after a participant’s death. In general, the IRS requires RMDs of the participant’s death benefit even if death occurs before age 70½. Consultation with a qualified tax expert would be needed as death benefits are a complicated tax area.
Watch for changes in plan demographics since RMDs may become more common with an aging participant population. Some plan sponsors employ third party service providers, such as the plan record-keeper, to administer the RMDs. However, the ultimate responsibility of ensuring the plan is operated in accordance with the IRS rules and regulations still remains with the plan sponsor. Plan sponsors should obtain an understanding of the processes used by the service provider as well as what input or approvals the service provider requires from the plan sponsor in order to perform the distribution. Additionally, sponsors should monitor the service providers to ensure the RMDs are made on a timely basis.
There are consequences if RMDs are not made timely. For the individual participant, the amount not withdrawn timely is taxed at a 50% rate. In a worst case scenario, a failure to make timely RMDs to eligible participants could cause loss of the tax exempt status for the plan, which would have devastating effects on all plan participants as well as significant tax consequences for the plan sponsor. However, this is generally rare as regulators try to avoid plans disqualifications, due to the harm it causes participants. Regulators instead provide sponsors with the opportunity to correct operational defects, such as this, through the IRS correction program, Employee Plans Compliance Resolution System (more commonly referred to as EPCRS, yet another industry acronym). Under EPCRS, a plan sponsor may use either the Self-Correction Program (SCP) or the Voluntary Correction Program (VCP) to correct RMD failures. There are benefits to both methods. The SCP, which is generally for small timely identified errors, does not require a filing or filing fee with the IRS whereas the VCP requires filing of a form and payment of a filing fee. A key benefit to the VCP is that the IRS will waive the 50% participant tax if the plan sponsor requests the waiver as part of the filing submission. If the VCP is not used and the participant requests a waiver, each affected participant or beneficiary must individually apply for a waiver of the 50% tax using the Form 5329 as part of their federal income tax return.
Understanding and monitoring RMDs is an important focus for sponsors since there are, to put it in social media terminology, consequences IRL (In Real Life) for missed or untimely RMDs. On a more serious note, RMDs are complex and consultation with a qualified tax expert is recommended. BDO is available to assist sponsors and fiduciaries in addressing the rules and considerations associated with RMDs.
This article originally appeared in The Newsletter of the BDO Employee Benefit Plan Audit Practice, Summer 2017 edition by Wendy Schmitz.