Distributions: Important Reminders

John Iekel

The rules and regulations governing distributions have changed in the last two years. In a recent ASPPA webcast, two experts provided some helpful reminders. 

In “FAQs about Distributions—it’s My Money and I Want it Now,” Robert M. Richter, J.D., LL.M., APM, American Retirement Association Retirement Education Counsel, and Bob Kaplan, CFP, CPC, QPA, American Retirement Association Director of Technical Education, discussed how some of the key rules concerning distributions have changed and what should be done under them. 

How Low Can You Go? 

Richter noted that distributions made to an individual before he or she is 59½ years old may be subject to a 10% additional tax under Code Section 72(t), unless the distributions fit within an exception to that tax.

Generally, one can’t distribute retirement plan amounts before a participant is age 59½, said Kaplan, but there is “no formal guidance on what the lower end could be” and on how young the triggering age can be. And even if the 10% tax applies, he noted, that “doesn’t mean it’s impermissible.”

Even so, he said, taking a distribution earlier than age 50 “defeats the purpose” of participating in a plan in the first place. “I’d be cautious about that,” he said. And, he said, “Even though the law says something can be done, the plan document still must provide for it. One is not automatically entitled to something just because the law allows it.” 

In-Service Distributions

Richter observed that the IRS has added a question and answer concerning in-service distributions to the frequently asked questions (FAQs) it provides concerning Coronavirus-related relief for retirement plans and IRAs.

The IRS says that a qualified pension plan generally may permit individuals who are working to begin receiving in-service distributions, generally if they have reached either age 59½ or the plan’s normal retirement age. 

But even before any COVID-related legislation was enacted, the Setting Every Community Up for Retirement Enhancement (SECURE) Act, which was enacted on Dec. 20, 2019, also contained provisions concerning in-service distributions. For pension, cash balance, money purchase and governmental 457(b) plans, the SECURE Act lowered the in-service distribution age from 62 to 59½. However, the provision is optional; under the SECURE Act, age 59½ does not need to be the plan’s normal retirement age in order for a participant to utilize it. 

Rehires

Richter and Kaplan said that the IRS also added an FAQ about the implications for distributions when an employee who has left service is rehired. 

The new FAQ says that if a plan sponsor rehires an individual due to unforeseen hiring needs related to the COVID-19 pandemic, the rehire generally will not cause that individual’s prior retirement to no longer be considered a bona fide retirement. 

It notes that Treasury regulations generally require a qualified pension plan to be maintained primarily to provide systematically for the payment of definitely determinable benefits over a period of years—usually for life—after either retirement or an individual reaching normal retirement age. 

Accordingly, says the IRS, a plan that does not permit in-service distributions may start making benefit distributions to an individual only when he or she has a bona fide retirement. Although the determination of whether an individual's retirement under a plan is bona fide is based on a facts and circumstances analysis, a rehire due to unforeseen circumstances that do not reflect any prearrangement to rehire the individual will not cause her or his prior retirement to stop being considered a bona fide retirement under the plan.

Richter told attendees that a plan can interpret whether it as to make a distribution based on its terms. And in situations in which the IRS has not issued guidance, Kaplan said, “You want consistency and you want documentation—a record of what you did and why you did it.”

Required Minimum Distributions

RMDs, which were waived for DC plans in 2020, are back for 2021 and must be taken for 2022, Richter and Kaplan reminded attendees. However, 2021 RMDs do not have to make up an amount that was not taken in 2020. 

New RMD age. The SECURE Act changed the RMD age to 72 for those born after June 30, 1949. Kaplan added that if a plan keeps the age 70½ RMD threshold, it’s not a distribution, it’s an in-service distribution. The year and a half lag, he said, is “problematic” and creates recordkeeping difficulties, he said, and when invoked means that the plan must provide an explanation. 

RMDs upon death. “Stretch” distributions to beneficiaries have been eliminated, Richter noted. The new rules generally apply to participants and beneficiaries who die after Dec. 31, 2019. They do not apply to DB plans. It is possible that there could be a delayed effective date for certain collectively bargained plans, and there are exceptions for the beneficiary of a beneficiary. 

The required beginning date is important if the participant is living and if there are non-designated beneficiaries, Richter said. He added that under the previous rules, payments had to be made every year; now, it is permissible to wait till the end of the 10-year period. 

Application of new tables. In general, the single life and uniform life tables reflect longer life expectancies, Kaplan and Richter said. The larger denominator means smaller RMDs, they added. 

The new uniform life table does not apply to 2021 RMDs distributed in 2022. The new table will apply to distributions attributable to the 2022 year, not 2021 RMDs paid in 2022.

Failure to take an RMD. A failure to take an RMD is an operational failure Kaplan and Richter warn, and the penalty is a painful 50%. If such a failure takes place, they suggest considering taking the following steps. 

• Pay the tax; use Form 5329–Part IX and Form 1040. 
• Request a waiver, and include a letter of explanation. 
• If the failure involves a beneficiary, withdraw the entire balance by end of 10th year following owner’s death (or 5th year if death was before 2020). 
• Remember that the lifetime stretch can only apply to a spouse, someone chronically ill or disabled, or those younger than age 10. 
• Use EPCRS for plan operational errors. 

Remember with self-correction methodology there will not be an automatic waiver from the IRS, Kaplan said. He said that the plan must consider the extent of the error, bring the parties together, and have the client make the decision. “You want to demonstrate to the IRS that you self-identified the problem and changed procedures to make sure it doesn’t happen again,” said Kaplan, adding that that “goes a long way” in helping one’s position with the IRS. 

Mega RMDs. These became an issue because some highly publicized accounts caught the attention of Congress, Richter and Kaplan said; Congress would not have been as concerned if it had been pre-tax., and is considering whether the government got tax revenue from it. 

The real issue, they say, is that mega RMDs: 

• do not involve Roths or conversions;
• some start-up stocks were valued very inexpensively and now are worth a great deal; and  
• Roth IRAs provide a tax-free vehicle in which to hold them.