RMDs and After-Tax contributions

[dmwe]

A retired participant who holds after-tax contributions in his account has been receiving RMDs for a few years. We have always calculated the after-tax to pre-tax dollars to be distributed on a prorata basis. Now this participant would like to roll his entire balance out of the Plan to an IRA and is insisting that the entire RMD for 2007 be made as a return of his after-tax basis but we don't agree. He thinks Q&A 9 in section 1.401(a)9-5 gives him that right. Any enlightenment from anyone on this issue would be appreciated.

[Guest mjb]

There is a PLR from the 1990s which allowed a particpant who received an LSD to roll over only the pre tax amount and receive the AT amounts as the MRD for the yr of distribution. I don't see where Q-9 disagrees with the concept that the AT funds are counted as MRDs in the yr of distribution.

[masteff]

Does anyone know the number of that PLR? Might be worth a quick read.

My thought is Q&A-9 doesn't create a choice whereby the participant can specify the source of the distribution where such a choice might not exist in the plan. It merely says the non-taxable portion of a distribution is counted towards satisfying the overall MRD for the year.

We had this debate once... final position was after-tax amounts in MRDs come out prorata as you are doing. Unfortunately I can't give you good cite as I've changed jobs since then.

Might review your plan text. You've been doing the MRD's prorata. Unless the plan explicitly provides the participant w/ the ability to specify the source of the distribution, then I wouldn't change at this point.

[Guest mjb]

The 1099R for a LSD paid to the participant will provide both the total amount and the AT amount. Since money is fungible why cant the AT amounts be used first to meet the MRD in 07 as provided in Q-9? Its not a source of distribution Q since the entire balance is being distributed in one yr and under Q-9 the AT portion of the distribution can be used to satisfly the MRD requirement as Q-9 makes clear.

[masteff]

I understand your point and a couple years ago I felt the same, but we found specific reasons having to do w/ the various complicated rules on recovery of after-tax monies that precluded an MRD coming solely from after-tax source. This was a very large debate w/ our recordkeeper and trustee. As I noted, I don't have access any more to that research to be able to recall the Code in question but it was very much an issue about after-tax recovery and how it applied to MRDs. Which is partially why it might be nice to see that PLR you referred to... to see if it gives any hints on where else to look.

[Guest mjb]

I dont understand why you need a PLR. The PLR predates the final reg which make it clear that all funds both pre and after tax are available in yr of distribution for MRD. In any event a reg is higher precedent than a PLR.

The only Q is whether the distribution is from an individual account in a DC plan.

[masteff]

There is a PLR...

I dont understand why you need a PLR...

Um, sorry, but I'm confused. You were the one who brought the PLR into the discussion.

[Guest mjb]

Taxpayers rely on plrs when there is no higher level of guidance. As I noted, at the time the plr was issued there were no final regulations on this issue. Now that there are final regs all taxpayers can rely on the final regs in Q-9 and not just the taxpayer in plr 9840041.

I would appreciate if you could articulate why you think the AT funds would not be eligible for the MRD since under Q-9 they are a distribution from the plan. I dont see how there can be any issue on the tax recovery of AT contributions since under the 401(a)(9) rules a lump sum distribution is a mrd from the payor plan for the yr distributed and the retention of the AT funds by the employee satisfy the mrd rules under Q-9.

[masteff]

As I already said...

Q&A-9 doesn't create a choice whereby the participant can specify the source of the distribution where such a choice might not exist in the plan. It merely says the non-taxable portion of a distribution is counted towards satisfying the overall MRD for the year.

The original poster stated they have treated the MRD's as prorata for the last couple years, therefore, unless the plan explicitly gives the participant the right to choose a source hierarchy for a withdrawal, then the participant has no right, under the plan or under Q&A-9, to dictate such.

[Bird]

I think it was correct to do prior "systematic" distributions on a pro rata basis and it is also correct now, when a lump sum total distribution is taken, to treat some or all of the post-tax recovery of basis as an RMD.

Forget about the RMD for a second. If a participant takes a lump sum and has after-tax money in the plan, he can roll over the pre-tax and take the after-tax in cash; there's no doubt about that, right? Now inject the RMD back into the equation; he has to take "x" and if he's receiving "x+y" then he's satisfied the RMD. It doesn't matter that "x" isn't taxable. There's no requirement that RMDs be taxable.

[masteff]

I think it was correct to do prior "systematic" distributions on a pro rata basis and it is also correct now, when a lump sum total distribution is taken, to treat some or all of the post-tax recovery of basis as an RMD.

Forget about the RMD for a second. If a participant takes a lump sum and has after-tax money in the plan, he can roll over the pre-tax and take the after-tax in cash; there's no doubt about that, right? Now inject the RMD back into the equation; he has to take "x" and if he's receiving "x+y" then he's satisfied the RMD. It doesn't matter that "x" isn't taxable. There's no requirement that RMDs be taxable.

And that was the position that we used to take, but after extensive discussion w/ our recordkeeper/trustee, we switched our point of view.

In one point of view there is a single lump sum distribution, part being rollover and part being MRD. In the other point of view, there are two separate distributions, one being a lump sum and one being a systematic distribution; the argument being that even if paid simultaneously, the MRD portion is still calculated on a systematic basis and does not lose that systematic nature.

Which point of view you take may also be a matter of what your system can accomodate. In a highly automated system that forces the MRD to be taken prior to any other distribution, it's going to effectively force you to the later point of view. Whereas a less automated system would allow for more individual discretion in how the after-tax money is allocated (to the extent the plan text provides such discretion).

[Guest mjb]

How does the automated system point of view apply to the tax reporting when the participant recieves the 1099R for the yr showing the LSD amount and the AT amount as being paid which will satisfy the MRD requirement from the payor's plan for the yr of distribution under Q-9? Why cant the P disregard the plan's reporting of the distribution as improper under Q-9 when the 1040 is filed?

[masteff]

Why cant the P disregard the plan's reporting of the distribution as improper under Q-9 when the 1040 is filed?

What the participant does on their individual tax return is outside of the plan and between the participant and the IRS. It certainly is a defensible position for a taxpayer to take, as evidenced by that PLR you noted where a similar position had a successful outcome.

[Guest mjb]

You still havent answered the Q of how the plan can report that the participant took a Part taxable mrd when the participant receives a LSD which will report the aggregate amounts as being paid by the plan including the aggregate AT amount. As I understand it the participant will be deemed to received the MRD for 2007 since he is receiving the LSD from the plan regardlesss of what portion is taxable or non taxable.

[masteff]

The participant will receive two 1099-Rs. One reflecting the MRD distribution w/ code 7. And one reflecting the direct rollover to the IRA with code G.

[Guest mjb]

But why wont the 1099 only reflect the $ amount of the MRD? How is the plan permitted to issue two 1099R for a LSD?

[masteff]

But why wont the 1099 only reflect the $ amount of the MRD? How is the plan permitted to issue two 1099R for a LSD?

Are you suggesting that the plan not issue a 1099-R for the rollover portion of the distribution? See page R-3 here: http://www.irs.gov/pub/irs-pdf/i1099r.pdf "You must report a direct rollover of an eligible rollover distribution."

The plan isn't "permitted to", they're absolutely required to! There have to be two 1099-Rs because the MRD is not rollover eligible and therefore must reported under code 7, whereas a rollover is reported under code G.

There would only be one 1099-R if and only if the participant did an indirect rollover which would be reported under code 7 and therefore combined w/ the MRD. However this would subject the entire distribution to income tax withholding and would have to be completed w/in 60 days. Because of the mandatory withholding, very few participants ever elect this method to complete a rollover.

[Bird]

I think I get it. If you processed a RMD in January, it would be pro-rated, and if the participant took a lump sum in December it would be part rollover and part tax-free but none of the second distribution would actually be taxable.

But if he doesn't take the RMD previously, the system forces the RMD out first as a pro-rata distribution following the above scenario, even if it happens at the same time.

Off the top of my head, a distribution can still qualify as a "lump-sum" distribution if taken in one year, so I'm pretty sure that the 1099-R should NOT reflect a pro-ration of taxable and non-taxable amounts in either scenario.

All is well with a pro-rata allocation until the moment that ALL of the money is taken out; at that point all the money previously withdrawn retroactively becomes a lump sum and is taxed differently (not pro-rated).

I can see where a highly automated system would want to do it with the RMD pro-rated, but the fact that the system is highly automated doesn't make it right. Someone should sit down with a typewriter and do the 1099-R manually if the system can't do it right.

[dmwe]

Unfortunately the Plan provides no guidance on the heirarchy of the distributions and the fact that there is post-tax and pre-tax money in the Plan.

Thanks for all of your input. We have taken the stance that we will allow the MRD to all come out of the after-tax source but we are still, for that source, going to distribute part basis and part earnings on a prorata basis.