“The IRS requires qualified plans to ensure that distributions commence no later than April 1 of the year following the year in which a participant turns 70 ½ and is terminated or retired,” explains Tim Driscoll, director of defined contribution product management for Fidelity’s Workplace Marketing, Solutions & Experience business in Smithfield, Rhode Island. Subsequent distributions must be made by December 31 each year.
The Internal Revenue Service (IRS) requires RMDs from participants who own individual retirement accounts (IRA) as well. Participants are prohibited from combining IRAs and qualified plans and taking the total amount from only one plan; this can be done with multiple IRAs, but not qualified plans, Driscoll says.
The amount a participant is required to withdraw is calculated by dividing the participant’s account balance as of December 31 of the previous year by his or her life expectancy factor. The IRS has published a Uniform Lifetime Table, which determines a participant’s life expectancy factor, Driscoll notes. For example, according to the table, the divisor for a 72-year-old participant is 25.6. If that participant had an account balance of $100,000 as of December 31 of the previous year, the RMD would be calculated dividing $100,000 by 25.6. The participant would be required to withdraw $3,906.25.
Under qualified plans, if the participant is not yet retired by age 70 ½, he can postpone RMDs until his retirement date. However, for participants who own 5% or more of the business sponsoring the plan, RMDs are required at age 70 ½, regardless of whether or not they have retired.
 Uniform Lifetime Table. Minimum Required Distributions (MRDs). Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917. https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/UniformLifetimeTable.pdf
What is the consequence if a participant misses the RMD date and does not withdraw the required amount? “It’s pretty harsh and it’s pretty severe in that the tax penalty is 50% of the required amount if it wasn’t distributed as it should have been,” Driscoll says.
With a harsh penalty and complexity in determining the RMD amount, it is important for plan sponsors to take steps to ensure their participants do not miss the date. Richter, vice president of SunGard’s wealth and retirement administration business in Jacksonville, Florida, points to the importance of plan sponsors knowing the age of participants. He says plan providers “will have processes in place to monitor when someone hits age 70 ½. It is part of their regular operations and procedures.”
Driscoll admits that being aware of participants turning 70 ½ “is a challenge for plan sponsors.” He explains the processes Fidelity uses to ensure its advisers takes action when a participant turns 70 ½. Fidelity’s RMD service identifies participants who are eligible for RMDs and sends distribution notifications to them—auto-notification. Next, the RMD will be calculated and the necessary checks will be distributed—auto-generation. The final process is generating a separate 1099-R, which summarizes RMD distributions and taxation for participant’s tax reporting purposes.
There is some complexity with the rules when calculating RMDs for beneficiaries of deceased participants. According to information provided by Driscoll, there are four different rule brackets depending on the beneficiary type and at what age the participant died. First, if the beneficiary is the spouse and the participant died before the RMD’s required beginning date then there are three options for the beneficiary’s required beginning date: December 31 of the year the deceased participant would have reached 70 ½; December 31 of the year following the year of death; or December 31 of the fifth year following the year of death.
Second, if the beneficiary is the spouse and the participant dies after the required beginning date then the decedent’s life expectancy is compared to that of the beneficiary’s, and the longer life expectancy of the two is used to calculate the RMD. This begins in the calendar year after the participant’s death and continues each year thereafter. The decedent’s life expectancy is reduced by 1 each year. In addition, in any case where the decedent had an RMD remaining in their year of death, the beneficiary must take that RMD amount for that year.
Third, if the beneficiary is non-spousal and the participant dies before the required beginning date then there are two options. The default one-year method uses the beneficiary’s life expectancy to calculate the RMD starting in the calendar year after the participant’s death, reducing by 1 each year thereafter. The five-year method requires the account to be paid out by December 31 of the fifth calendar year following the date of death. This is used when the one-year rule is missed or the beneficiary elects this method by September 31 of the calendar year following the year of death.
Fourth, if the beneficiary is non-spousal and the participant dies after the required beginning date then the decedent’s life expectancy is compared to that of the beneficiary’s and the longer life expectancy of the two is used to calculate the RMD. This begins in the calendar year after the participant’s death and continues each year thereafter. The decedent’s life expectancy is reduced by 1 for each year after, while the beneficiary’s life expectancy is reduced by 1 starting in the second year after the participant’s death. As is the case when the beneficiary is a spouse and the participant dies after the required beginning date, if the decedent had an RMD remaining in their year of death, the beneficiary must take that RMD amount for that year.
Latest Modification to RMD Rules
There has been a recent development impacting RMDs, which involves a modification earlier this year to the regulation dealing with qualified lifetime annuity contracts (QLAC). The final rules make longevity annuities more accessible for workplace retirement savers by amending RMD regulations so that longevity annuity payments will not need to begin prematurely in order to comply with those regulations (see “Final Rules Seek to Expand In-Plan Longevity Annuity Access”).
Under the final rules, a 401(k) or similar plan, or IRA custodian, may permit account holders to use up to 25% of their account balance or $125,000, whichever is less, to purchase a qualifying longevity annuity without concern about noncompliance with the age 70½ minimum distribution requirements.
“Congress realizes that these RMD rules may run counter to the fact that they want to ensure that people don’t outlive the account,” Richter says. “I think that’s why you’re seeing a shift now between tax policy of wanting to collect taxes and the retirement policy of ensuring participants do have adequate retirement savings.”
Richter explains that QLACs are annuities that don’t start paying until late in life. The maximum age to begin payment is 85. The idea is that a participant uses a portion of his or her account by this annuity contract and it will begin paying at some point later in life. If the contract is payable at age 85 then the participant can be assured that he or she will have a stream of payments from this annuity contract by age 85. If the participant wipes out everything else, at the very least he or she will have some protection on the back end, Richter says.