Correcting RMDs

[Guest PJW]

We are attempting to self correct the failure to make RMDs for multiple years. According to ECPRS, the correction method is to essentially get the RMDs out of the plan. Under ECPRS, RMDs are calculated by dividing the adjusted account balance by the applicable divisor. I understand that the adjusted account balance is reduced by the amount of total missed distributions, but I can't tell how earning and losses are factored in.

Could someone please tell me how earnings or losses are factored into calculatiing RMDs under ECPRS? For example, is a correction made if the RMD is distributed, but the gains on the RMD for the period in which those amounts were suppose to be out of the plan are not?

[Tom Poje]

There is an example given under Q & A 77/ Q & A Columns/ Correcting plan defects It goes back a few years, but what the heck.

SVP Correction for Failure to Make Required Minimum Distributions

(Posted May 11, 1998)

Question 77: We are continuing our series of questions which look at using the Standardized VCR Program ("SVP") corrections for defects under the Administrative Policy Regarding Self-Correction ("APRSC"). In Revenue Procedure 98-22, the IRS says that SVP corrections are deemed to be reasonable and appropriate methods of correcting under all the remedial programs; therefore, plan sponsors who correct using the SVP methods have "reliance" under APRSC that the correction will be acceptable to the IRS. In this Q&A, we address the following question: "What is the form of correction mandated under SVP for failure to make minimum distributions under Code section 401(a)(9)?"

Answer: Appendix A to Revenue Procedure 98-22 lists the operational failures and acceptable methods of correction under SVP. One of the specified defects is the failure to pay minimum required distributions under Code section 401(a)(9) on a timely basis. (Even though amended in 1996 in the Small Business Job Protection Act, section 401(a)(9) still requires that qualified plans make distributions after age 70-1/2 to "5% owners" and to non-5% owners when they terminate service after reaching age 70-1/2.)

The form of correction under SVP differs depending on the type of plan. For defined contribution plans, the correction is to distribute the missed required minimum distributions. How do you know what to distribute? The amount for each year is determined by dividing the "adjusted account balance" as of the valuation date for each distribution by the "applicable divisor" (which is the remaining years of projected life expectancy of the participant and any designated beneficiary). The adjusted account balance is determined by reducing the actual account balance at each valuation date by the missed distributions from prior years. This sounds more complicated than it is.

Let's use an example to illustrate the methodology. Assume the participant has an account balance of $50,000, that there are no forfeitures or contributions added to the account, that the earnings rate on the account is 10%, and that the life expectancy of the participant and the designated beneficiary is 20. The normal minimum distribution in the first year would be $2,500 ($50,000 divided by 20), and for each subsequent year would be the remaining account balance divided by the remaining life expectancy. In the second year, the distribution would be about $2,763 ($50,000 less $2,500 plus $5,000 of earnings divided by 19 years), and so on. The SVP correction method effectively assumes that the required distributions were made each year in order to determine the next year's required distribution, and then the missed payments are added together and distributed at one time to complete the correction.

For defined benefit pension plans, the correction method under SVP is to distribute the required minimum distributions plus "an interest payment representing the loss of use" of the funds. There is no guidance on how to determine the interest rate, but a rate approximating the plan's rate of return on its assets would be acceptable to the IRS.

In our next Q&A, we will discuss other issues related to correction of a failure to distribute required minimums, including the resolution of excise taxes due under Code section 4974.