Retirement Plan Correction Solution
I Am Running Away from My RMD Problems…. And It Feels Good

 Carolyn Cumbee, Esq.

Michael Scott is a regional manager of a local paper company, Dunder Mifflin Paper Company.  Dunder Mifflin offers its employees the benefit of a qualified retirement plan, which has been in existence since the company started in 1956.  Michael has been tasked with finding a new third-party administrator (“TPA”) because their prior TPA is retiring.

In January 2023, Michael agreed to engage a local TPA called Scranton Benefits.  Meredith, the administrator assigned to the Dunder Mifflin plan, has been reviewing the plan documents, recent valuations, and current census.  She discovered that one former employee, Creed Batton, has attained age 75, but hasn’t taken his required minimum distributions (“RMD”) for 2020, 2021, and 2022.  She presents this issue to Michael so that they can resolve it quickly.

Meredith tells Michael that Creed attained 70 ½ on October 10, 2018. Therefore, he should have taken his first RMD by April 1, 2019, and another by December 31, 2019.  But Meredith sees that no additional RMDs have been taken. Michael informed Meredith that Creed died suddenly back in December 2020, which makes the problem more complicated.  Michael completely forgot about Creed’s balance in the Plan. Meredith noted to Michael that this should be fixed, since missed RMDs generally trigger excise taxes, payable by the person who should have received the distribution. In addition, a plan’s failure to pay RMDs violates Internal Revenue Code (“Code”) Section 401(a)(9), so it can cause plan disqualification, as well.

The Impact of the CARES Act

Meredith asks Michael if he can find a beneficiary designation for Creed, and also whether they signed a CARES Act Amendment, which may have waived the RMD requirements for defined contribution plans for 2019 and 2020.  Since Michael is the regional manager of a paper company, Michael has paper records of all plan documentation.  He is able to locate Creed’s beneficiary designation dated in 2018, which names his much-younger coworker, Kelly Kapoor, as his beneficiary. Luckily for Michael, Kelly still works at Dunder Mifflin, so he doesn’t need to work hard to track her down. Michael also locates a signed CARES Act Amendment, which provides that participants are not required to take RMDs due from the Plan during 2020.

 Determine the Missed Required Minimum Distribution

The method to calculate an RMD provides that the participant’s account balance as of the specified valuation date is divided by the applicable distribution period.  This calculation is done each year during the participant’s lifetime, up to and including the year of the participant’s death.

The account balance is determined as of the plan’s last valuation date for the year before the distribution calendar year, which is the year to which the distribution relates.  If the last valuation date isn’t December 31, then the account balance should be adjusted for contributions, distributions, and forfeitures occurring between the valuation date and the year end.

The distribution period is based on the age of the participant on his or her birthday during the distribution calendar year.  The regulations include a Uniform Lifetime Table that provides for a uniform distribution period for all participants of the same age.  For example, the distribution period for a participant aged 72 is 27.4.  The Uniform Lifetime Table must be applied, unless the sole beneficiary of the participant is the spouse and the spouse is more than 10 years younger than the participant.  In that case, the distributions are based on a longer distribution period using the Joint and Last Survivor Table. For the 2020 RMD, we divide Creed’s December 31, 2019 account balance by 27.4, since Creed turned 72 in 2020.  The amount of the 2020 RMD would be the same whether Creed died before or after his birthday.  However, because of the CARES Act amendment, no RMD was due for 2020.

RMDs generally continue to be required after the participant’s death and are paid to the beneficiary. The RMD requirements after a participant’s death are based on several factors:

* whether the participant died before or after the RBD,

* whether the participant died after the SECURE effective date (generally after 2019),

* the status of the recipient–spouse, designated beneficiary (generally an individual beneficiary), or other recipient (such as an estate or charity), and

* the ages of the recipient and the participant.

If the participant died after 2019, whether a designated beneficiary is an “eligible designated beneficiary” also enters the picture.  Kelly is not an eligible designated beneficiary because she is more than 10 years younger than Creed. This means that Kelly must empty the account by the December 31, 2030, ten years after Creed’s death. It also means, based on the proposed regulations, that Kelly should have continued to take the RMDs for the period between Creed’s death and the ultimate payout of the entire account.  Therefore, she owes late RMDs for the last few years.

The 2021 RMD is based on the Creed’s December 31, 2020 account balance. This is divided by a distribution period based on Kelly’s age in 2021 and the Single Life Table included in the regulations.

Adjustment for Earnings and Multiple Missed RMDS

When an RMD is late, the amount required to be distributed to correct the failure to satisfy the RMD rules must be adjusted for earnings, calculated from the date of the failure to the date of actual distribution.  Meredith tells Michael that she can apply actual earnings to these amounts since that data is available, and EPCRS doesn’t specify the formula for applying earnings.

Since Kelly missed multiple RMDs, the account balance at each December 31^st valuation date must be reduced by the missed RMD from prior years for purposes of calculating that year’s required distribution.  This would allow the balance to be properly adjusted to reflect the full correction of the late RMDs.

Excise Tax and Form

Generally, an excise tax is imposed on the participant or beneficiary who fails to take an RMD on time under Code Section 4974 equal to 50% of the undistributed RMD amounts.  The excise tax is reported on Form 5329 for the participant (or beneficiary, as required), reflecting the 50% amount due.  However, the instructions to the Form 5329 explain that the IRS is willing to waive the penalty for reasonable cause.  A reasonable cause letter may accompany Form 5329 and the payment, requesting a waiver of the penalty, which should explain the reason for the error and how it is being corrected.  If there are errors for multiple years, a separate Form 5329 should be filed for each year for which there was an error, using the form from that year.

Note that, thanks to SECURE 2.0, this draconian penalty will ease up for future years.  Effective for RMDs due during the 2023 tax year, the excise tax under Code Section 4974 will be reduced from 50% to 25%.   Further, if a participant/taxpayer catches and corrects the failure before the last day of the second taxable year after the taxable year in which the failure occurred, the amount is reduced to only 10%.  This should encourage people like Kelly to just pay the taxes and make the correction.  (The ability to request a full waiver of the excise tax using a Form 5329 will continue even after the tax rate goes down.)

Special IRS Action: Notice 2022-53

Meredith informs Michael that the IRS released Notice 2022-53 last year, which provides that a defined contribution plan will not be considered as having failed to satisfy the Code just because it didn’t make a “specified RMD” for 2021 or 2022.  It also said that there is relief from the 50% excise tax penalty for taxpayers who didn’t take the 2021 and 2022 RMD. “Specified RMDs” include, in particular, amounts that were due in those years to certain beneficiaries of participants.

This means that a beneficiary of a participant who died in 2020 or 2021 after reaching his RBD will not be penalized for failing to take the RMD in 2021 or 2022, as long as the beneficiary is not taking lifetime or life expectancy payments.  This saves Kelly from having to pay excise taxes for those years.

The Correction for Missed RMDs

As mentioned above, an RMD is generally due for the deceased participant in the year of death.  However, the Plan elected the RMD waiver for 2020 under the CARES Act; therefore, no correction is needed for the missed 2020 RMD for Creed.

Despite the lack of penalty for not distributing an RMD for 2021 and 2022, Meredith expressed that Kelly may be required to “make up” these distributions at a later time. The IRS indicated clearly that no penalty will be assessed, but it is unclear if the RMDs still need to be paid for that time period.  So, Kelly elects to take the RMDs now to make up for the missed payments. She doesn’t need to file Form 5329 for 2021 and 2022 for these missed payments since no excise tax will apply.