Participant's required beginning date was 4/1/04 but entire balance rolled into IRA when employment terminated in 2003. Trouble? How to fix?

[nancy]

I have a non 5% owner who attained age 70 1/2 in 2002. He terminated in August 2003 and rolled all of his money to an IRA. Should he have received a minimum distribution from the 401(k) plan even though his RBD is 4/1/04? What is the remedy?

[Mike Preston]

Yes, he should have. Write him a letter telling him that $X was not rollable and that if not removed from the IRA before 4/15/04 will be treated by the IRS as an IRA contribution on behalf of 2003. If $X exceeds the allowable personal IRA contribution available to participant, excise taxes will be due. Then call the participant and offer to help them work with their financial institution to have the monies withdrawn from the IRA. Might be a pain. Goal is to have the financial institution treat the withdrawal as a minimum distribution, but may have trouble because no IRA account balance on 12/31/2002.

[jevd]

If client turned 70 1/2 in 02 then no IRA contribution is available. The financial institution will treat as removal of excess rollover. Probably should talk to tax preparer about treating the excess amount as being taxable in year 03 ( taken from 401k as difference between amount received and amount rolled over) as the RMD. Then earnngs on excess will be taxable but no penalty.

[Appleby]

I agree with most of the posts above, but just want to paraphrase a little

Did you mean to say he reached age 70 ½ in 2003 (not 2002)?

If so, then:

Yes. He should have retained the RMD amount and rollover the balance to his IRA…

Since he did not, the RMD amount is treated as an ineligible rollover contribution. He should notify his IRA custodian about the ineligible rollover contribution…the IRA custodian will then recharacterize the excess amount to an IRA contribution (instead of a rollover contribution).

Since he is over the age limit, he is not eligible for an IRA contribution, which means the entire amount (representing the RMD from the 401(k) plan), is now an excess IRA contribution for year 2003. Therefore, the notification of the ineligible rollover to the IRA custodian should include a request to remove the amount as a ‘return of excess contribution’. The distribution/‘return of excess contribution should include any earnings or minus any loss on the excess amount while it was in the IRA. If there are any earnings, the earnings will be taxable in 2003.

The IRA owner may be required to calculate the earnings/loss him/herself…but some custodians do offer that service. If you need assistance with calculating the earnings let me know.

The RMD amount is taxable in 2003.

[nancy]

No, he attained age 70 1/2 in 2002. His RMD is 4/1/04 because that is the April 1 following retirement.

[Appleby]

If he attained age 70 ½ in 2002, then his RBD is 04/01/03.

If he did not distribute the RMD for 2002 by 04/01/03, then he may owe the IRS a 50 percent excess accumulation penalty.( 50 percent of the RMD amount that was not distributed)

The explanations given above would apply to the RMD for 2003.

[R. Butler]

If he attained age 70 ½ in 2002, then his RBD is 04/01/03.

Why is that the case? If it is a non 5% owner & the document so allows then wouldn't the RBD be the later of 4/1 following 70 1/2 or the 4/1 following retirement? In this case that 4/1/04.

[Appleby]

Well I'll be d _ _ _ _!!!

I did not see the 'non'. Shows why you must must must RFQ!

Failing to RFQ is the stuff failing exams are made of y'know

[mbozek]

A non 5% owner in a qualified plan over age 70 1/2 is not required to commence mrd until the april 1st following the year of retirement. If he retired in 8/03 then he has until 4/1/04 to commence mrds. IRC 401(a)(9). Technically he should have had the MRD for 03 withheld from the distribution but he can take his mrd from the IRA by 4/1/04.

[jevd]

I disagree.The first distributions in a year for which an RMD is required are considered to be RMDs and therefore are ineligible for rollover. The RMD from the qualified plan was required for 2003. You have an ineligible rollover in the amount of the RMD subject to the rules for excess IRA contributions. Since the individual is over 70 1/2, there is no option to consider it a valid IRA contribution. It must be removed or it is subject to penalities and additional taxation if not removed by the deadlines.

[Appleby]

jevd is right

[pmacduff]

I'm confused. Why was an '03 distribution required? Is it because the participant was already 70 1/2? The original post said that this was a NON owner, therefore 1st minimum required is due April 1st following actual retirement (you all seem to agree on that). In this case, the April 1st following actual retirement is 04/01/2004. You are not required to take an RMD early, just allowed to. This participant would then have to take 2 RMDs in 2004 if the $ was still in the qualified plan. So - why is the entire distribution done in 2003 not eligible for rollover if the 1st RMD is not due until 04/01/2004? Is it because the $ is leaving the qualified plan and moving to an IRA? Different RMD rule for QP & IRA? Just trying to learn here - I work with QPs and want to be sure I understand if this issue comes up for me...thanks in advance.

[Appleby]

pmacduff , an RMD for 2003 is required because that is the year that the first RMD is due. Any distributions that occur in the year an RMD is due is attributed to the RMD amount , until the RMD amount is satisfied. Treas Reg § 1.402(c )-2, Q&A 7. This rule is the same for IRAs and qualified plans

The 04/01 is just an extension to distribute the RMD for the first year. If you already distributed enough to satisfy the RMD in 2003, then the 04/01/04 deadline does not rally apply anymore. This extension ( 04/01) is for those who did not satisfy the RMD by 12/31

[pmacduff]

Appleby - Thanks for the reply - I guess I am asking - is 2003 the 1st RMD year because the participant retired in 2003 and was already 70 1/2? NOT because he was 70 1/2 in 2002 and 1st RMD would have been due by April 1, 2003 originallly? I think the timing of his turning 70 1/2 in this example is what is threw me....

[Appleby]

You’re welcome pmacduff. Excellent question to clarify that point.

Yes. The RMD is due for 2003 because the participant retired in 2003 and was already 70 ½.

For instance, since the participant is already 70 1/2, if he retired in 2007, even though the RBD would be 04/01/08, the RMD would be due for 2007 and any amount distributed in 2007 would be attributed to the RMD until the RMD has been met.

[Lynn Campbell]

If a participant inadvertently rolled over the entire account balance to an IRA in 2003 (non 5% owner, over age 70 1/2 when he quit working in 2003), and the excess is withdrawn by 4/15/2004 with applicable earnings, what penalties are there? Has anyone had success in convincing the IRA Custodian to remove these funds, and what is the best way to start? Thanks for all input.

[TBob]

Lynn - If the ineligible rollover is removed from the IRA before 4/15/04 then there are no penalties. If there are earnings distributed with the excess they are taxable but no penalty.

Also, the participant should note that since the RMD was not eligible for rollover (as they initially thought) it is a taxable distribution from the qualified plan in the year it was distributed from the plan which in your case was 2003. The 1099R's from the plan should reflect this but it probably is not a bad idea to remind the participant because they may not have claimed it as income if they have completed their 2003 filing already.

As far as getting the IRA custodian to cooperate...I can't really say. We usually send a letter to the participant with a copy to the IRA custodian explaining things. That is usually where it ends. I would think that IRA custodians would encounter this situation often enough to be aware that it could happen and should not have any problem with the correction. It is really on the participant's shoulders to make sure the IRA custodian complys with his request to remove the excess rollover.

My 2 cents worth...

[rcline46]

Although I agree with the answers, I have a more basic question -

Why does everyone think the RMD date (for first RMD distribution only) is 4/1/xx??

It is not and never has been 4/1! It has always been 12/31. They allow it to be postponed to 4/1 of the next year, but one should NEVER confuse a postponement with what the date really is.

IMHO of course.

[mbozek]

I dont understand how the MRD is taxed in 2003 if it is not distributed to the participant until 2004. Individuals are cash basis taxpayers who are taxed in the year of payment, not when the payment accrues. While the 1099-R may show what is the amt eligible for rollover, the 1099-R cant report a distribution for 2003 which was not paid to the participant. The fact an MRD was inadvertenly rolled over does not mean it is paid to the participant. Under the IRC if the first MRD is paid between 1/1/-4/1, it is attributed to the year the participant attained age 70 1/2 but is taxed in the year paid. The solution is for the participant to withdraw the MRD from the IRA by 4/1.

[Appleby]

Although I agree with the answers, I have a more basic question -

Why does everyone think the RMD date (for first RMD distribution only) is 4/1/xx??

It is not and never has been 4/1!  It has always been 12/31.  They allow it to be postponed to 4/1 of the next year, but one should NEVER confuse a postponement with what the date really is.

IMHO of course.

I think we all agree that the first RMD is applicable to the year-ending 12/31 for the year the first RMD is due. However, ( to answer your question) we think the RBD (deadline to distribute first RMD amount) is 04/01 of the year following the year in which the individual reached age 70 ½ (or retires in the case of a QP/non-5 percent owner) because it simply is…As you know, the 04/01 date is significant for beneficiaries, because if the retirement account owner died before this date, he she is treated as being deceased before the RBD, for purposes of the options available to the beneficiaries. This is so even if he/she died after 12/31---but before 04/01 and even if he/she distributed the RMD before 04/01

[Appleby]

Lynn - If the ineligible rollover is removed from the IRA before 4/15/04 then there are no penalties. If there are earnings distributed with the excess they are taxable but no penalty.

Also, the participant should note that since the RMD was not eligible for rollover (as they initially thought) it is a taxable distribution from the qualified plan in the year it was distributed from the plan which in your case was 2003. The 1099R's from the plan should reflect this but it probably is not a bad idea to remind the participant because they may not have claimed it as income if they have completed their 2003 filing already.

As far as getting the IRA custodian to cooperate...I can't really say. We usually send a letter to the participant with a copy to the IRA custodian explaining things. That is usually where it ends. I would think that IRA custodians would encounter this situation often enough to be aware that it could happen and should not have any problem with the correction. It is really on the participant's shoulders to make sure the IRA custodian complys with his request to remove the excess rollover.

My 2 cents worth...

TBob

The earnings would also be subject to the early distribution penalty, unless an exception applies.

Regarding the IRA custodian’s handling of the request….all the custodian needs is their I the custodian’s) ‘distribution request form’ completed and signed by the IRA owner…indicting that the distribution is a ‘return of excess contribution’,

For instructions with calculating the earnings on the excess contribution to the IRA http://benefitslink.com/boards/index.php?showtopic=23288 (not all custodian will calculate the earnings)

mbozek,

Technically, the amount is distributed to the individual in 2003, and is therefore taxable in 2003. Remember, the 1099-R issued for the ineligible rollover amount (the RMD amount) removed/distributed from the IRA will show the amount as non-taxable… They are two separate transactions, 1)- a distribution of an ineligible-rollover amount, which is taxable in the year distributed and 2) an amount contributed to an IRA that does not meet the contribution eligibility requirements.

If I may draw on another example…assume the individual is receiving substantially equal periodic payments, and chooses to rollover one of the payments. We know this amount is not rollover eligible. However, the 1099-R will correctly report the amount as taxable. It is then incumbent upon the individual to remove the ineligible contribution from the IRA.

In the example being discussed, the 1099-R should be corrected – for correction purposes, two 1099-Rs should be issued, one to show the RMD amount as taxable, and the other to show the balance as being processed as a direct rollover.

[TBob]

The earnings would also be subject to the early distribution penalty, unless an exception applies.

I am a little confused by your post, Appleby. In the context of Lynn's question we are talking about a participant that rolled over the RMD amount and the penalties that could apply. I am not sure how the 10% early distribution penalty would come into play here since the participant is definitely over age 59 1/2. Am I missing or misunderstanding something?

There are only two penalties that I can think of that one might we worried about here.

50% penalty for not satisfying the RMD requirement - In this case the RMD requirement is satisfied because the first payments out of the plan are treated as satisfying the RMD requirement in a year in which there is a RMD required. Even if the entire amount is rolled over, the RMD requirement has been met by the plan. Treas Reg 1.402©-2, Q&A 7. The only problem is that a portion of the amount distributed is ineligible for rollover. I agree that there should be 2 1099R's from the plan. One for the RMD amount and the other for the remaining rollover amount.

Which brings into play the second penalty...6% penalty on an excess contribution to an IRA. To avoid the penalty the ineligible rollover plus earnings must be removed from the IRA before 4/15. The earnings must be included here or they will be subject to the penalty.

[mbozek]

You are confusing two separate tax law provisons- One is the requirement that MRDs cannot be rolled over with the requirement that a participant is taxed when the distribution is paid to him in a check. The fact that the plan is not supposed to roll over the MRD is a requirement for qualification but the participant does not have imputed income if the amount if the entire distribution is rolled over (since constructive receipt does not apply). There is not such thing as "technical" taxation of distributions from retirement plans under the tax law. A cash basis taxpayer is taxed when amounts are paid to him not when the amounts are imputed or construtively received. A distribution is not taxed to a taxpayer if no check is issued to the taxpayer and this defect cannot be corrected by issuing a 1099-R that shows a MRD in 2003. I understand that the plan admin is in a difficult position because the MRD was not distributed but the PA cannot correct the problem by issuing a 1099-R showing a distribution which is not made in 2003 and for which there is no 20% withholding. In your example the 1099-R correctly reports the amount distributed to the participant because a check was issued to the participant which is not the case where the MRD is paid to the IRA.

[TBob]

mbozek - How do you suggest that this should be corrected? I understand your logic with regard to the check not being paid to the participant but I am at a loss as to how else you would handle this?

I have always looked at this from the plan's perspective. The money was distributed. The first chunk of the amount distributed was an RMD. The rest was rollover.

Sal suggests the same method in the 2003 Edition of the ERISA Outline, Chapter 6, Part G(3)(b).

[mbozek]

The best alternative would be for the Plan Admin to notify the participant of the mistake and request that the participant direct the custodian to do a trustee to trustee transfer of the MRD back to the plan and have the plan send the MRD to the participant. This is requires that the MRD be distributed by Dec 31. If the participant does not return the funds then the PA should inform the participant to withdraw the MRD from the IRA by 4/1 and file the 1099-R showing the amount of the rollover.

I think there is confusion on what is a distribution. Under the IRC a direct rollover to an IRA custodian is not a distribution to the participant even if an MRD is included in the amount rolled over.

[Lynn Campbell]

This is a follow up to my earlier post:

I just realized that the person paid in this case had NOT terminated employment when his entire balance was rolled over. So he was over 70 1/2, but not a 5% owner and still working at the time of distribution of his entire account balance. I assume this means there is no issue with a RMD for that distribution, even though he did terminate employment later in that same calendar year (5 months later). Is this a correct interpretation? I assume all RMDs would be paid from his IRA Account? Thanks!

[Appleby]

The earnings would also be subject to the early distribution penalty, unless an exception applies.

I am a little confused by your post, Appleby. In the context of Lynn's question we are talking about a participant that rolled over the RMD amount and the penalties that could apply. I am not sure how the 10% early distribution penalty would come into play here since the participant is definitely over age 59 1/2. Am I missing or misunderstanding something?

There are only two penalties that I can think of that one might we worried about here.

50% penalty for not satisfying the RMD requirement - In this case the RMD requirement is satisfied because the first payments out of the plan are treated as satisfying the RMD requirement in a year in which there is a RMD required. Even if the entire amount is rolled over, the RMD requirement has been met by the plan. Treas Reg 1.402©-2, Q&A 7. The only problem is that a portion of the amount distributed is ineligible for rollover. I agree that there should be 2 1099R's from the plan. One for the RMD amount and the other for the remaining rollover amount.

Which brings into play the second penalty...6% penalty on an excess contribution to an IRA. To avoid the penalty the ineligible rollover plus earnings must be removed from the IRA before 4/15. The earnings must be included here or they will be subject to the penalty.

TBob,

Your statement was

“ If the ineligible rollover is removed from the IRA before 4/15/04 then there are no penalties. If there are earnings distributed with the excess they are taxable but no penalty.” 

....You are right is saying there are no penalties…it however appeared you were referring to the 6-percent excise penalty. Also, your reference to earnings can only apply to earnings accrued on the excess while it was in the IRA, since it only becomes an excess in the IRA and only then earnings are distributed with the amount.. . The issue of earnings would not apply to the Q.P. Therefore, my comment was in response to the meaning portrayed in your comment.

mbozek – I have to agree with TBob about ‘looking at it from the plan’s perspective’, because he/she is right.

As you know, the first amount distributed from the plan (regardless of to what of whom paid), includes the RMD amount.

As you know, an RMD amount is not rollover eligible. Therefore, the error is that the RMD amount was rolled to the IRA. Your position is that the direct rollover is technically not a distribution to the IRA owner…but it is… Look at 408(d)(5)(B), which provides for the correction of an ineligible rollover, if the ineligible rollover is due to erroneous information. This supports the position that an amount rolled to the IRA can be a distribution, if it is ineligible to be rolled over…and that it can be corrected by removing the amount from the IRA-not by returning the amount to the plan as you suggested. Further, under this Code Section, the ineligible rollover amount returned to the IRA owner is non-taxable…which is not the case for other excess IRA contributions. .. the amount is non-taxable because any taxable treatment would have been applied to the funds when it was distributed from the plan…