Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Hinkle Law...

Key Concepts for Required Minimum Distributions from IRAs and Qualified

Retirement Plans

Hinkle Law Firm LLC301 North Main

Suite 2000Wichita, Kansas 67202-

4820(316) 267-2000

www.hinklaw.com

Steven P. Smith & Jason P. LaceyMay 20, 2014

Foulston Siefkin LLP1551 N. Waterfront Parkway

Suite 100Wichita, Kansas 67206

(316) 267-6371www.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

May 20143Copyright © 2014 by Hinkle Law Firm LLC

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?


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


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) May 20146Copyright © 2014 by Hinkle Law Firm LLC

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


RMD Rules Set Outer Limits

The RMD rules establish The latest possible distribution date,

and The minimum possible distribution


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


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


DISTRIBUTIONS BEFORE DEATH

May 2014Copyright © 2014 by Hinkle Law Firm LLC 11

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% ownerMay 201412Copyright © 2014 by Hinkle Law Firm LLC

Example Assume the following:

Mary Ann’s 70th birthday is today (May 20, 2014)

She has money in IRAs with: First National Bank Fidelity Vanguard


Required Beginning Date How long can Mary Ann wait before

she has to start taking money out of her IRAs?


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

2014May 201415Copyright © 2014 by Hinkle Law Firm LLC

Mary Ann’s First Distribution Calendar

Year Why is her first distribution calendar

year 2014 (and not 2015)?


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


First Payment How much does Mary Ann have to

take in her first payment?


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



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



– 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



– 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?


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



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



– 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


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


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


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


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


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


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


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?


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


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


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


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


DISTRIBUTIONS AFTER DEATH


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”


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


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)


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


MISCELLANEOUS


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


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


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


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


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


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


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


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


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


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

planMay 201452Copyright © 2014 by Hinkle Law Firm LLC

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


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


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


Thank You

Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Hinkle Law...

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