Transcript Jason Lacey/Steve Smith - Wichita State University
Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans
Steven P. Smith & Jason P. Lacey May 20, 2014 Hinkle Law Firm LLC 301 North Main Suite 2000 Wichita, Kansas 67202-4820 (316) 267-2000 www.hinklaw.com
Foulston Siefkin LLP 1551 N. Waterfront Parkway Suite 100 Wichita, Kansas 67206 (316) 267-6371 www.foulston.com
Some Numbers
Retirement plans have lots of money IRAs hold an estimated $4 trillion 401(k) and other qualified plans hold an estimated $3.2 trillion Most of that money was contributed on a pre tax basis That means that it has not yet been taxed Copyright © 2014 by Hinkle Law Firm LLC 2 May 2014
Taxes Must be Paid
Sooner or later, this money must be taxed The “required minimum distribution” rules are designed to make sure that, sooner or later, this money does get taxed Copyright © 2014 by Hinkle Law Firm LLC 3 May 2014
Focus of the RMD Rules
The RMD rules focus on two questions: When does the money have to start coming out?
How much money has to be taken out each year?
In other words, how long can the process be dragged out?
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Application of the RMD Rules
The RMD rules apply to: Individual retirement accounts (IRAs) 401(k) and other qualified plans 403(b) plans 457(b) plans There are some variations in how the rules apply to each of these, but, for the most part, the rules are the same Copyright © 2014 by Hinkle Law Firm LLC 5 May 2014
Sources of Law
Code § 401(a)(9) applies to qualified plans Code § 408(b)(6) provides that rules “similar to” 401(a)(9) apply to IRAs Code § 403(b)(10) provides that rules “similar to” 401(a)(9) apply to 403(b)s Code § 457(d)(2) provides that a 457(b) plan must meet the requirements of 401(a)(9) Copyright © 2014 by Hinkle Law Firm LLC 6 May 2014
Regulations
Proposed regulations were issued in 1987 2001 Final regulations were issued in 2002 The 2002 regulations also included one section that was issued in temporary form That section was finalized in 2004 The 2002 / 2004 final regulations apply to all calendar years after 2002 Copyright © 2014 by Hinkle Law Firm LLC 7 May 2014
RMD Rules Set Outer Limits
The RMD rules establish The latest possible distribution date, and The minimum possible distribution Copyright © 2014 by Hinkle Law Firm LLC 8 May 2014
Qualified Plans – Commencement Dates
Qualified plans do not have to wait until the latest possible distribution date before commencing benefits Many (and probably most) plans require distributions to commence if a participant has Terminated employment, and Attained age 65 Copyright © 2014 by Hinkle Law Firm LLC 9 May 2014
Qualified Plans – Installment Distributions
Many 401(k) plans require participants to take their benefits in the form of a lump sum payment This payment can be rolled over to an IRA Payments can be taken from the IRA in installments Copyright © 2014 by Hinkle Law Firm LLC 10 May 2014
DISTRIBUTIONS BEFORE DEATH
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When do payments have to begin?
No later than the “required beginning date” (“RBD”) RBD is generally April 1 of the calendar year following the later of the calendar year in which: The payee attains age 70½, or The participant terminates employment with the employer maintaining the plan (in the case of an employer-sponsored plan) But only if the payee is not a 5% owner Copyright © 2014 by Hinkle Law Firm LLC 12 May 2014
Example
Assume the following: Mary Ann’s 70 th birthday is today (May 20, 2014) She has money in IRAs with: First National Bank Fidelity Vanguard Copyright © 2014 by Hinkle Law Firm LLC 13 May 2014
Required Beginning Date
How long can Mary Ann wait before she has to start taking money out of her IRAs?
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Mary Ann’s RBD
Her RBD is the April 1 of the first calendar year beginning after the calendar year in which Mary Ann turns 70½ Mary Ann will be 70½ in November 2014 This means that Her RBD is April 1, 2015 Her first distribution calendar year is 2014 Copyright © 2014 by Hinkle Law Firm LLC 15 May 2014
Mary Ann’s First Distribution Calendar Year
Why is her first distribution calendar year 2014 (and not 2015)?
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Distribution Calendar Year
A “distribution calendar year” is a calendar year for which a distribution must be made When an individual turns 70½, a distribution must be made for that calendar year Exception may apply if the individual is still working for the employer sponsoring the plan Although the individual’s RBD is April 1, the distribution that must be made by April 1 is actually on account of the previous calendar year Copyright © 2014 by Hinkle Law Firm LLC 17 May 2014
First Payment
How much does Mary Ann have to take in her first payment?
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Mary Ann’s First Payment
The amount of Mary Ann’s first payment depends on her life expectancy factor This is set forth in the Uniform Lifetime Table A different table will apply if she has a spouse who is more than 10 years younger Copyright © 2014 by Hinkle Law Firm LLC 19 May 2014
Mary Ann’s First Payment
The Uniform Lifetime Table provides a distribution period based on the participant’s age Age is determined as of the birthday that falls within the distribution calendar year Mary Ann will be 70 on her 2014 birthday Remember: Although her RBD is April 1, 2015, her first distribution calendar year is 2014 Copyright © 2014 by Hinkle Law Firm LLC 20 May 2014
Mary Ann’s First Payment – How Much?
To determine how much Mary Ann has to take, her account balance is divided by her distribution period under the Uniform Lifetime Table Under the Uniform Lifetime Table, her distribution period is 27.4
If her account balance is $100,000, her distribution for 2014 would be: $100,000 / 27.4 = $3,649.64
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Mary Ann’s First Payment – What Account Balance?
When we calculate the payment that Mary Ann has to receive by her RBD, what account balance do we use?
In other words, the account balance as of what date?
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Valuation Calendar Years
The account balance for purposes of determining the required minimum distribution for a distribution calendar year is The account balance As of the last valuation date In the calendar year immediately preceding the distribution calendar year For most plans, this will be December 31 Special rules may apply if the valuation date is not December 31 Copyright © 2014 by Hinkle Law Firm LLC 23 May 2014
Mary Ann’s First Payment
Mary Ann’s RBD is in 2015 The payment she must receive is for 2014 Her valuation calendar year for this payment is 2013 So her required payment for 2014 must be based on her 2013 account balance Normally, this will be the balance as of the last day of the year Note that the balance is not adjusted for distributions made after 12/31/13 Copyright © 2014 by Hinkle Law Firm LLC 24 May 2014
Mary Ann’s First Payment – Which IRAs?
Is Mary Ann required to take a distribution from each of her IRAs?
The RMD rules allow IRAs to be aggregated So, the RMD rules will be satisfied as long as the total amount taken from any combination of her IRAs is enough to satisfy her required distribution for her distribution calendar year Copyright © 2014 by Hinkle Law Firm LLC 25 May 2014
Subsequent Years
The required distribution for each distribution calendar year after the first distribution calendar year must be taken by December 31 of that calendar year This means that Mary Ann’s distribution for 2015 must be taken by 12/31/2015 The April 1 deadline applies only to her first distribution calendar year If she waits until 2015 to receive her distribution for 2014, she could (and probably will) end up receiving two distributions in the same calendar year Copyright © 2014 by Hinkle Law Firm LLC 26 May 2014
401(k) Plans
What if Mary Ann also had balances in three separate 401(k) plans?
401(k) plans are not aggregated This means that required distributions must be separately calculated for each 401(k) plan Copyright © 2014 by Hinkle Law Firm LLC 27 May 2014
Working Past Age 70
What if Mary Ann is still working?
No impact on required distributions from IRAs 401(k) plans of former employers But distributions are not required from the 401(k) plan of her current employer Unless she is also a 5% owner This is true even if she is only working part-time Copyright © 2014 by Hinkle Law Firm LLC 28 May 2014
Roth Money
What if one of the IRAs is a Roth IRA and Mary Ann has made Roth deferrals in one of the 401(k) plans?
Roth IRAs are not subject to the RMD rules while the account holder is still alive But Roth money in a 401(k) plan is treated the same as any other money for purposes of the RMD rules Copyright © 2014 by Hinkle Law Firm LLC 29 May 2014
Roth Money
What can Mary Ann do to avoid having to receive distributions of the Roth money in the 401(k) plans?
Mary Ann may want to roll that money over to a Roth IRA Unless the Roth money is in the 401(k) plan of her current employer and she is not a 5% owner To avoid having to receive a distribution for the 2014 calendar year, she may want to complete the rollover before the end of 2013 Copyright © 2014 by Hinkle Law Firm LLC 30 May 2014
Planning Opportunities – Delaying Distributions
What if Mary Ann is still working and wants to delay distributions as long as possible?
Mary Ann may wish to roll her other 401(k) money and the money in her IRAs into the 401(k) plan of her current employer This assumes The plan accepts rollovers She is not a 5% owner The plan has reasonable investment choices Copyright © 2014 by Hinkle Law Firm LLC 31 May 2014
Consequences of Not Taking an RMD
What if Mary Ann fails to receive a required distribution from one of her 401(k) plans by her RBD?
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Consequences of Not Taking an RMD
She is subject to an excise tax Excise tax is 50% of the amount that should have been paid but was not Form 5329 must be attached to taxpayer’s return for the year in which the amount should have been paid The 50% excise tax is in addition to the tax that will be owed as a result of including the distribution in her taxable income Copyright © 2014 by Hinkle Law Firm LLC 33 May 2014
Waiver of Excise Tax – by the Plan
The 401(k) plan can apply for a waiver of the excise tax on her behalf The IRS has a specific procedure for this But the plan is not required to request a waiver Copyright © 2014 by Hinkle Law Firm LLC 34 May 2014
Waiver of Excise Tax – Requested by Individual
Mary Ann may request a waiver of the excise tax Waiver must be requested using Form 5329 Excise tax may be waived if the shortfall was Due to reasonable error, and Taxpayer is taking reasonable steps to remedy the shortfall Copyright © 2014 by Hinkle Law Firm LLC 35 May 2014
Waiver of Excise Tax – Automatic Waiver
Excise tax will automatically be waived if Participant dies before his/her required beginning date The beneficiary is an individual, and The participant’s total benefit is distributed to the beneficiary by the last day of the fifth calendar year following the year of death Copyright © 2014 by Hinkle Law Firm LLC 36 May 2014
DISTRIBUTIONS AFTER DEATH
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Already in Pay Status
What if Mary Ann begins taking distributions in 2015 but dies in 2016?
Year of Death – assume she lived until December 31 Pay to beneficiary if she did not take a distribution before death Later Years – pay over her remaining life expectancy or, if longer, the life expectancy of her “designated beneficiary” Copyright © 2014 by Hinkle Law Firm LLC 38 May 2014
Death Before Payment Begins
What if Mary Ann died in 2013?
5-Year Rule – Distribute all within 5 years Life Expectancy Rule – If she has a designated beneficiary, begin by the end of the year after death and pay over beneficiary’s life expectancy Spouse Rule – If her spouse is her beneficiary, begin by the later of (1) end of the year after death, or (2) end of the year she would have been 70½, and pay over spouse’s life expectancy Copyright © 2014 by Hinkle Law Firm LLC 39 May 2014
Designated Beneficiary
General Rule – Must be an individual designated under the plan or IRA Can be an affirmative designation or designation by default under plan/IRA terms Certain trusts can count as “individuals” Determine on September 30 of year following year of death (must have also been a beneficiary as of date of death) Copyright © 2014 by Hinkle Law Firm LLC 40 May 2014
Why Does It Matter?
Assume Mary Ann dies in 2013 and names: Her estate Her 20-year-old granddaughter A trust of which her three children are the sole beneficiaries A trust of which her three children and a charity are the beneficiaries Copyright © 2014 by Hinkle Law Firm LLC 41 May 2014
MISCELLANEOUS
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Non-Spouse Beneficiaries
Mary Ann names her daughter as sole beneficiary of her 401(k) account and dies before her RBD General Rule – Could use life-expectancy payout over daughter’s life But what if the plan only allows lump-sum distributions?
Her daughter can Roll over the distribution to an inherited IRA Take installment distributions from the inherited IRA Copyright © 2014 by Hinkle Law Firm LLC 43 May 2014
Forms Not Returned
Ginger dies in 2011 At the time of her death, she was 69 years old not married, and had not commenced benefits from her 401(k) plan Her beneficiary form designated her two adult children as her beneficiaries However, her children did not return the forms that were needed to process a distribution until 2013 Copyright © 2014 by Hinkle Law Firm LLC 44 May 2014
Is there a problem?
Under the plan’s RMD provisions, distributions to a non-spouse beneficiary should have commenced by December 31, 2012 In other words, by the end of the calendar year following the year of death Copyright © 2014 by Hinkle Law Firm LLC 45 May 2014
What should have happened?
The plan provided that the default form of distribution for a non-spouse beneficiary would be installment payments over the beneficiary’s life expectancy However, the plan also provided that beneficiaries could elect to apply the five year rule instead if they did so by September 30 of the calendar year in which distribution was required to begin Under Reg. § 1.401(a)(9)-3, Q&A-4(c), the latest possible date for making an election would be December 31 But, in this example, the plan is requiring an election to be made as of an earlier date This is not uncommon in our experience Copyright © 2014 by Hinkle Law Firm LLC 46 May 2014
What should have happened?
Ginger died in 2011 So distributions were required to begin by December 31 of the year following Ginger’s death, i.e., December 31, 2012 This means that the deadline to elect the five year rule was September 30, 2012 Copyright © 2014 by Hinkle Law Firm LLC 47 May 2014
Deadline missed – What next?
Because this deadline was missed, it is too late for the beneficiaries to elect to follow the 5 year rule This means that they each needed to take a required payment for 2012 Because the 2012 payment will not be made until 2013 (at the earliest), they will be exposed to the 50% excise tax on that payment Copyright © 2014 by Hinkle Law Firm LLC 48 May 2014
Separate Accounts?
The beneficiaries could have elected to establish separate accounts This would allow each of them to use their own life expectancy Otherwise, the life expectancy of the oldest beneficiary must be used However, the deadline for establishing separate accounts for this purpose was the last day of the year following the calendar year of the participant’s death That is, December 31, 2012 Copyright © 2014 by Hinkle Law Firm LLC 49 May 2014
Separate Accounts?
Separate accounts may still be established, but, because this deadline was missed, each beneficiary will have to use the life expectancy of the oldest beneficiary Copyright © 2014 by Hinkle Law Firm LLC 50 May 2014
Rollover to Inherited IRA?
The two beneficiaries should be able to accelerate their remaining distribution and roll them over into their own inherited IRAs Note, however, that They cannot rollover their required payments for 2013 even though they are not required to receive those payments until December 31, 2013 They need to take their required payment for 2013 before they make a rollover They are still locked in to taking installment distributions Copyright © 2014 by Hinkle Law Firm LLC 51 May 2014
Defined Benefit Plans
A qualified plan that is also a defined benefit plan is subject to the RMD rules Because a defined benefit plan provides ongoing monthly payments, it will almost always satisfy the RMD rules if payments are commenced at the right time The most common problem: A participant dies, but no one tells the plan Copyright © 2014 by Hinkle Law Firm LLC 52 May 2014
DB Plan - Example
Participant dies in 1994 Upon his death, a death benefit becomes payable to his wife But no one tells the plan that he has died Two years later, his wife also dies She died intestate She had one surviving son No estate was ever opened The plan finds out about his death in 2005 This was after the son was released from the state penitentiary Apparently he didn’t want to receive money while he was locked up because he was afraid he might not get to keep it Copyright © 2014 by Hinkle Law Firm LLC 53 May 2014
What should the plan do?
Death benefit is owed and must be paid Upon the participant’s death, the death benefit became payable to his surviving spouse The right to receive that payment passed to her estate upon her death Under state law, because a formal estate was never opened, her surviving son was entitled to receive the payment based on his affidavit of heirship Copyright © 2014 by Hinkle Law Firm LLC 54 May 2014
Example – Excise Tax
50% excise tax is still owed!
Payment was not made within the RBD for a nonspouse beneficiary Should have been paid to the surviving son no later than the end of the fifth calendar year following the date of the wife’s death She died in 1996 So by the end of 2001 To avoid the excise tax, the surviving son will have to request a waiver from the IRS using Form 5329 Copyright © 2014 by Hinkle Law Firm LLC 55 May 2014