MRD before Lump sum Rollover Not Processed

[Guest CJA]

Non-5-percent owner retires after age 701/2 and has not taken any distributions from her 401(k). She requests a direct rollover of account balance. When an amount is distributed from a plan in a rollover transaction, that amount is still treated as a distribution in determining whether the distributing plan has satisfied MRD requirements. In this situation, it is my understanding participant must first receive a MRD (reported on a 1099) and then the rollover to the IRA may occur (reported on a separate 1099).

We have discovered that TPA (who is responsible for calculating MRD's and processing and reporting all transactions) has not been processing the MRD's in situations such as the one described above for 2006 and 2007 tax years. TPA has been rolling over 100% of participants' account balances. I have been advised that this can cause excess IRA contribution issues, late MRD excise taxes, among other headaches including possible plan disqualification. TPA has suggested correcting this by now issuing "new" 1099-Rs reporting the transactions as if they had properly been processed, and then leave it up to former participants to work with IRA provider to make corrections to their IRA accounts. This sounds absurd. I know I need Tax/ERISA counsel. But has any one ever heard of such a mess and how TPA should correct?

[Kimberly S]

I believe that it is technically up to the participant, not the TPA, to make sure that he or she actually took the required minimum distribution somewhere, but we all know how likely that is to happen correctly. You might start by asking the participants if they took the RMD after the transfer. For those that did, you may not need to do anything else.

Correcting a 1099-R that acurately reflects what happened to something that shows what you wish had happened is not an appropriate action.

[Guest Sabadee!]

Issuing past years 1099's puts the participant at a disadvantage owing back taxes & penalties. The "pretending we did it right" correction sounds like a lazy TPA. For the Plan's benefit, the TPA should prepare a VCP submission. 401(a)(9) failures are a canned solution and with the VCP, the participants are forgiven any penalties. The cleanest way is to see if the participants/IRA custodians will transfer back the amounts incorrectly rolled (they shouldn't issue a taxable 1099, it's to a Q.P.) and then the plan can issue the make-up distributions taxable in the current year with the IRS' blessing. If that isn't an option VCP might allow you to amend the past 1099R's reflecting the smaller rollover and issue current year taxable ones from the Plan. That's a little more tricky.

With the VCP, nobody gets hurt and the plan is protected. I would think in this situation, the TPA would be happy to prepare the VCP and the subsequent corrections, 1099s, etc. free of charge. It beats an E & O claim if the plan gets caught.

[PLAN MAN]

In the past we have sent letters to the IRA provider informing them that there was an incorrect rollover and a portion of the amount may not be included in the account. We instructed the IRA provider to return to the plan the amount we determined to be the RMD. Upon return, we processed the RMD and issued correct tax forms for the transactions.

[Appleby]

I believe that it is technically up to the participant, not the TPA, to make sure that he or she actually took the required minimum distribution somewhere, but we all know how likely that is to happen correctly. You might start by asking the participants if they took the RMD after the transfer. For those that did, you may not need to do anything else.

Correcting a 1099-R that acurately reflects what happened to something that shows what you wish had happened is not an appropriate action.

It seems the TPA is right, primarily because of the first paragraph in the CJA’s post.

The participants now need to remove the amounts from the IRAs as return of excess contributions.

[Appleby]

In the past we have sent letters to the IRA provider informing them that there was an incorrect rollover and a portion of the amount may not be included in the account. We instructed the IRA provider to return to the plan the amount we determined to be the RMD. Upon return, we processed the RMD and issued correct tax forms for the transactions.

The IRA custodian should not process transactions based on instructions from anyone, other than the IRA owner. It is true some do honor such requests, but they should not. The notification should be sent to the IRA owner, and the IRA owner should take the return-of-excess path to correct the ineligible rollover.

[Bird]

It seems the TPA is right, primarily because of the first paragraph in the CJA’s post.

The participants now need to remove the amounts from the IRAs as return of excess contributions.

I agree. The money left the plan, therefore the RMD from the plan was satisfied. But, it was not eligible for rollover, so the proper correction is to issue a revised 1099-R showing the RMD as not being eligible for rollover. It's happened to us once, maybe twice, although I think we've always caught it before issuing the 1099-R and simply filed it correctly in the first place (and of course notified the participant and told them to take the money out). It's really not that big of a deal.

[Guest Sabadee!]

The treatment is different than I originally thought. See the below Q&A from the Treas.Reg.

G-1B. What are the tax consequences under section 402(a) and 408(d) to an employee who rolls over an amount which is required under section 401(a)(9)?

A. The tax consequences under section 402(a) and 408(d) to an employee who rolls over an amount which is required to be distributed under section 401(a)(9) are as follows:

(a) The amount which is required to be distributed under section 401(a)(9) is taxable under section 72 in the taxable year in which distributed without regard to the rollover.

(b) If the amount which is required to be distributed under section 401(a)(9) is contributed to an individual retirement plan as a rollover contribution, such amount will be treated as a contribution to an individual retirement plan which is not a rollover contribution and thus will be an excess contribution for purposes of section 4973 if the amount is not deductible under section 219 or may not be treated as a nondeductible contribution under section 408(o). Of course, if the amount is an excess contribution, it may be withdrawn with earnings from the account before the due date of the employee's return pursuant to section 408(d)(4) in order to avoid imposition of the excise tax under section 4973.

G-2. Q. If an amount is distributed by one plan (distributing plan) and is rolled over to another plan (receiving plan), how are the benefit and the minimum distribution under the receiving plan affected?

A. (a) Except as otherwise provided in paragraph (b), if an amount is distributed by one plan (distributing plan) and is rolled over to another plan (receiving plan), the benefit of the employee under the receiving plan is increased by the amount rolled over. However, the distribution has no impact on the minimum distribution required to be made by the receiving plan for the calendar year in which the rollover is received. But, if a minimum distribution is required to be made by the receiving plan for the following calendar year, the rollover amount must be considered to be part of the employee's benefit under the receiving plan. Consequently, for purposes of determining any minimum distribution for the calendar year immediately following the calendar year in which the amount rolled over is received by the receiving plan, in the case in which the amount rolled over is received after the last valuation date in the calendar year under the receiving plan, the benefit of the employee as of such valuation date, adjusted in accordance with F-5, will be increased by the rollover amount valued as of the date of receipt. For purposes of calculating the benefit under the receiving plan pursuant to the preceding sentence, if the amount rolled over is received by the receiving plan in a different calendar year from the calendar year in which it is distributed by the distributing plan, the amount rolled over is deemed to have been received by the receiving plan in the calendar year in which it was distributed by the distributing plan.

(b) If an amount is distributed by the distributing plan after the employee's required beginning date under both the distributing plan and the receiving plan, and the designated beneficiary of the employee under the receiving plan is a designated beneficiary with a life expectancy that is longer than the life expectancy of the designated beneficiary under the distributing plan, the following rule will apply. In such case, the receiving plan must separately account for the amount rolled over and treat it as a separate benefit. It must then begin distribution of such separate benefit in the calendar year following the calendar year in which the amount rolled over was distributed by the distributing plan. The separate benefit attributable to the rollover amount must be distributed over a period not exceeding the period (including any adjustments for recalculation under section 401(a)(9)(D), if applicable) used by the distributing plan to determine the employee's minimum distribution with respect to the benefit attributable to the amount rolled over. For purposes of determining the life expectancies or lives used to determine the minimum distribution under the receiving plan, the designated beneficiary under the distributing plan will be the designated beneficiary under the receiving plan (with respect to the benefit attributable to the amount rolled over). If such beneficiary is changed under the receiving plan to a different beneficiary from the designated beneficiary under the distributing plan, or a beneficiary is added who was not a beneficiary under the distributing plan, the rules in E-5 applicable to changes in beneficiaries will be used to determine the period over which distributions must be made by the receiving plan.

[BG5150]

Does EPCRS (VCP) have an explanation on what to do for transactions over a year old?

We have a person who took a full rollover distribution in May of 2007 before the RMD was taken. This was discovered just recently.

The only thing I saw in EPCRS on 401(a)(9) was dealing with a late RMD but before the money was rolled out.

[Guest mjb]

Does EPCRS (VCP) have an explanation on what to do for transactions over a year old?

We have a person who took a full rollover distribution in May of 2007 before the RMD was taken. This was discovered just recently.

The only thing I saw in EPCRS on 401(a)(9) was dealing with a late RMD but before the money was rolled out.

Did the participant attain age 70 1/2 in 2007 which made the required beginning date 4/1/08?

[BG5150]

Participant terminated 5/1/07 and took full r/o distribution 5/14/2007. He was 75 at the time. (non-owner)