RMD from Roth elective deferrals

[K2retire]

• New 401(k) plan established in 2009.
  
• Business owner born in 1939.
  
• All of the money in the owner's account is Roth elective deferral source.
  
• Spouse/beneficiary is 13 years younger.
  

It appears that the owner will be required to take 4 RMDs before the 5 year period is satisfied. (Obviously, he is annoyed that no one mentioned the 5 year rule, or RMD rules, before he set up the plan.) This year's RMD amount will be ridiculously small.

Is it possible to specify that the distribution is all basis and leave the earnings in the plan?

[mbozek]

• New 401(k) plan established in 2009.
  
• Business owner born in 1939.
  
• All of the money in the owner's account is Roth elective deferral source.
  
• Spouse/beneficiary is 13 years younger.
  

It appears that the owner will be required to take 4 RMDs before the 5 year period is satisfied. (Obviously, he is annoyed that no one mentioned the 5 year rule, or RMD rules, before he set up the plan.) This year's RMD amount will be ridiculously small.

Is it possible to specify that the distribution is all basis and leave the earnings in the plan?

why not take MRD for 2010 and before Dec 31, 2010 roll over the rest to a Roth IRA which has no mrds?

[K2retire]

The plan does not allow for in-service distributions of Roth balances.

[mbozek]

The plan does not allow for in-service distributions of Roth balances.

I am nolt following. Every 401k plan I have ever seen allows in service distributions after 59 1/2. If not amend the plan.

Who would pick a plan that doesnt allow for inservice withdrawals?

Another idea. What prevents the owner from withdrawing more than the MRD for year (e.g. the entire balance) since IRC 401(a)(9) requires that the plan must allow the account balance to be withdrawan at 70 1/2?

[Tom Poje]

well, what if for the remainder of the year the owner makes deferrals to non-Roth accounts. maybe its a stretch, but...

Granted he had no $ in a non-roth account before that date (I assume) but I don't recall reading anywhere that a minimum distribution has to come from a specific source, but rather it simply has to be made in an amount sufficent to cover the min distribution amount. e.g. I know of no one who says the min distrib is $500, lets see 42.3 has to be from deferral, 23.67 has to be from match and the rest from profit sharing because on 12/31/2010 thats the way the balances were.

[GMK]

Who would pick a plan that doesnt allow for inservice withdrawals?

me.

It's a retirement plan for when you retire. In service withdrawals are allowed after 70-1/2.

In service withdrawals eat up retirement savings, which I've been told is bad (unless you have a separate pile of money for retirement, I suppose.)

But seriously, you seem pretty adamant about this, and I would like to know why allowing post 59-1/2 withdrawals is so important. Thanks.

[Guest Sieve]

Some employers/TPAs don't want to allow inservice Roth distributions because they do not want to deal with the ordering rules, 5-year holding rules, etc., so I have seen many plans where in-service (age 59-1/2) distributions, hardships & loans cannot come from Roth accounts.

[masteff]

...but I don't recall reading anywhere that a minimum distribution has to come from a specific source...

To the contrary, a major national recordkeeper/investment firm argues that all MRDs are annuitized payments and must come out prorata from all sources. We fought w/ them for nearly a year before deciding we couldn't win and turned belly up to their attys. (Note: I personally agree w/ Tom.)

[Tom Poje]

wow, that thought never even crossed my mind. I've never even seen an example which said minimum distribution is $5000 and you must take x% from deferral, y% from match and the remainder from ps. I guess that must be taken the interpretation that you can't aggregate plans (e.g. money purchase and profit sharing together - the regs even have examples of that as failing minimum distributions)

closest I see to addressing it in the regs is 1.401(a)(9)-8 q-2 which asks if the regulations apply seperately to each seperate account in a DC plan

and the answer was they are aggregated unless they are divided into separate accounts by each beneficiary.

oh well, teach this old dog some new tricks.

[mbozek]

Some employers/TPAs don't want to allow inservice Roth distributions because they do not want to deal with the ordering rules, 5-year holding rules, etc., so I have seen many plans where in-service (age 59-1/2) distributions, hardships & loans cannot come from Roth accounts.

We are talking about a rollover to a Roth IRA at 70 1/2 to prevent MRDs. Why would a plan not provide that option to avoid the participant having to take MRDs? I dont know of anything the the IRC which prevents a tax free rollover of a Roth 401k account to a Roth IRA if there is a distribution event. In any event why can't the participant take the entire Roth account balance as the MRD at 70 1/2?

[GMK]

My sense from the OP is that the participant does not want to rollover all or even part of the balance. He probably has access to better investment options in the plan than out in the IRA world. (Just guessing.)

But I agree that amending to allow distributions at 70-1/2 makes sense. And then he could roll the RMD's to a Roth IRA.

[mbozek]

Who would pick a plan that doesnt allow for inservice withdrawals?

me.

It's a retirement plan for when you retire. In service withdrawals are allowed after 70-1/2.

In service withdrawals eat up retirement savings, which I've been told is bad (unless you have a separate pile of money for retirement, I suppose.)

But seriously, you seem pretty adamant about this, and I would like to know why allowing post 59-1/2 withdrawals is so important. Thanks.

Because inservice withdrawals allow plan participants to roll over to IRAs which provide better investment options at cheaper costs. Vanguard has many mutual funds and ETFs that are available for a fraction of the fees charged by plans (less than 30BP).

If inservice withdrawlas are allowed at 70 1/2 in the plan you described in your OP why is there a problem with allowing the owner to roll over the balance of the Roth account to a Roth IRA after the mrd is withdrawn?

[GMK]

Thank you for your reply, mbozek.

I understand your point, and I agree with the big emphasis on lower fees. If one can do better outside the Plan, then that is a strong argument for in service withdrawals before 70-1/2.

Sometimes, even with Vanguard funds, the plan can get a better fee class than the lowly individual, mainly because the plan has a bigger pile of money to invest, so it can access the lower fee fund grades. Plans can also provide access to (non-Vanguard) lower fee institutional grade funds with consistently high returns that are not generally available to most individuals.

I think it depends on what the plan provides for investment options, which of course can include properly (read 'low') priced Vanguard funds. It also depends on whether the plan really works at offering low fee funds that provide consistently good performance.

One hang up I have with access at 59-1/2 is that there's no way to restrict it only to rollovers. Yes, it's their money. And why should I care if they spend it and have nothing left when they retire? Well, we set up the plan to be a retirement plan, so that employees have the opportunity to build up some savings for those golden years. And the company puts in a healthy match to encourage deferrals and to help build employee's account faster. We are very reluctant to encourage employees to lose track of the goal. But that's just us.

Happy Thanksgiving. And thank you for all your posts, which are always worth reading.

[mbozek]

Thank you for your reply, mbozek.

I understand your point, and I agree with the big emphasis on lower fees. If one can do better outside the Plan, then that is a strong argument for in service withdrawals before 70-1/2.

Sometimes, even with Vanguard funds, the plan can get a better fee class than the lowly individual, mainly because the plan has a bigger pile of money to invest, so it can access the lower fee fund grades. Plans can also provide access to (non-Vanguard) lower fee institutional grade funds with consistently high returns that are not generally available to most individuals.

I think it depends on what the plan provides for investment options, which of course can include properly (read 'low') priced Vanguard funds. It also depends on whether the plan really works at offering low fee funds that provide consistently good performance.

One hang up I have with access at 59-1/2 is that there's no way to restrict it only to rollovers. Yes, it's their money. And why should I care if they spend it and have nothing left when they retire? Well, we set up the plan to be a retirement plan, so that employees have the opportunity to build up some savings for those golden years. And the company puts in a healthy match to encourage deferrals and to help build employee's account faster. We are very reluctant to encourage employees to lose track of the goal. But that's just us.

Happy Thanksgiving. And thank you for all your posts, which are always worth reading.

While institutional funds are cheaper than retail funds sold to individuals, they are cheaper because they provide less services to the plan than retail funds which means that the plan must pay other providers for these services. For example inst. funds do not perform due dilligence for compliance with securities laws, don't provide recordkeeping, don't offer call centers or investment education or tax reporting, all which are necessary for a qualified plan but are not required by other institutional investors such as tax exempt organizations, banks, insurance companies or hedge funds.

In other words the employer, plan or the participants are paying some else for administration costs which are not performed by the institutional funds. If the participant moves his funds to an IRA he will not be assessed any cost other the management fee.

As for allowing participants who will not do a roll over to access their money at 59 1/2, does it really matter how long the plan delays allowing participants the opportunity to spend their retirement funds instead of using it for retirement? If they havent learned that they need to save their 401k funds for retirement by 59 1/2 they will never learn.

Have a Happy turkey day. I will spend it watching a lot of football.

[K2retire]

Some employers/TPAs don't want to allow inservice Roth distributions because they do not want to deal with the ordering rules, 5-year holding rules, etc., so I have seen many plans where in-service (age 59-1/2) distributions, hardships & loans cannot come from Roth accounts.

We are talking about a rollover to a Roth IRA at 70 1/2 to prevent MRDs. Why would a plan not provide that option to avoid the participant having to take MRDs? I dont know of anything the the IRC which prevents a tax free rollover of a Roth 401k account to a Roth IRA if there is a distribution event. In any event why can't the participant take the entire Roth account balance as the MRD at 70 1/2?

Due to the concerns Larry mentioned, all of our plans a written to prohibit hardship, in-service and loans from Roth balances. Because we have no idea if our recordkeeping system will accurately track the basis vs. potentially taxable income following partial withdrawals, amending the plan is not an option at this point.

Ironically, the document also specifies that the RMD can only be the minimum amount calculated, not the entire balance.

And yes, the point is that he doesn't want to withdraw anything.

[Tom Poje]

masteff: now you got me real curious. (I know you already agree, but for the sake of the argument)

in the case discussed here, it was a new plan. lets suppose NRD was 65/5 and there was a match subject to vesting.

so the individual in question has both deferral and 0% vested match.

Now, 1.401(a)(9)-5 Q/A 8 ask what if a protion is not vested how does that effect the calculation. it still requires the min distribution to be determined based on the total balance.

...and if the "total amount" of the employee's vested balance is less than the required minimum distribution, only the vested portion is required to be distributed.

Now, based on your comments the investment house would say you have to take money from the match source, but since it is 0 vested that would be impossible.

however, I would read the reg to say you look at the total vested balance, and pay out if you can, which would certainly be the case if deferrals are involved.

gobble gobble from Tom Turkey

[masteff]

masteff: now you got me real curious. (I know you already agree, but for the sake of the argument)

in the case discussed here, it was a new plan. lets suppose NRD was 65/5 and there was a match subject to vesting.

so the individual in question has both deferral and 0% vested match.

Now, 1.401(a)(9)-5 Q/A 8 ask what if a protion is not vested how does that effect the calculation. it still requires the min distribution to be determined based on the total balance.

...and if the "total amount" of the employee's vested balance is less than the required minimum distribution, only the vested portion is required to be distributed.

Now, based on your comments the investment house would say you have to take money from the match source, but since it is 0 vested that would be impossible.

however, I would read the reg to say you look at the total vested balance, and pay out if you can, which would certainly be the case if deferrals are involved.

gobble gobble from Tom Turkey

Tom, I'd agree w/ that vesting would still trump so if you only had 2 sources then you might pay out solely from the vested one. -- Looking back thru my CCH Master Pension Guide... my best recollection is that Sec 402(a) points you to Sec 72 and that Fidelity argued that if it looked like an annuity and smelt like an annuity (and how can you argue that MRD's are not based on life expectancy) then you had to do prorata as an annuity in order to acheive return on investment in the contract. I'll note that prior to Roth accounts, the only other place it truly mattered was a) after-tax contributions and b) legacy sources solely invested in specific investments (e.g. a stock only permitted to be held in one particular legacy source, such as prior plan match invested in prior company stock). (or at least those are the two places it made my life miserable.)

[Tom Poje]

I asked the lady in the office who used to work for an investment house or two - she says it has more to do with their distribution forms - one house has only one spot to put the total dollar amount, so they do it pro rata, another house has a form that you can indicate what source the $ should come from, so I guess its going to vary from one investment house to another.

I guess I can sorta see the argument for it being an annuity (in a way) but only 'cuz I'm ready to run out the door and have a few days off.

[BG5150]

RMDs have been around for years and years. I'm sure if the RMD had to be taken pro rata an agent or investigator or two would have brought this up a long time ago.

[mbozek]

masteff: now you got me real curious. (I know you already agree, but for the sake of the argument)

in the case discussed here, it was a new plan. lets suppose NRD was 65/5 and there was a match subject to vesting.

so the individual in question has both deferral and 0% vested match.

Now, 1.401(a)(9)-5 Q/A 8 ask what if a protion is not vested how does that effect the calculation. it still requires the min distribution to be determined based on the total balance.

...and if the "total amount" of the employee's vested balance is less than the required minimum distribution, only the vested portion is required to be distributed.

Now, based on your comments the investment house would say you have to take money from the match source, but since it is 0 vested that would be impossible.

however, I would read the reg to say you look at the total vested balance, and pay out if you can, which would certainly be the case if deferrals are involved.

gobble gobble from Tom Turkey

Tom, I'd agree w/ that vesting would still trump so if you only had 2 sources then you might pay out solely from the vested one. -- Looking back thru my CCH Master Pension Guide... my best recollection is that Sec 402(a) points you to Sec 72 and that Fidelity argued that if it looked like an annuity and smelt like an annuity (and how can you argue that MRD's are not based on life expectancy) then you had to do prorata as an annuity in order to acheive return on investment in the contract. I'll note that prior to Roth accounts, the only other place it truly mattered was a) after-tax contributions and b) legacy sources solely invested in specific investments (e.g. a stock only permitted to be held in one particular legacy source, such as prior plan match invested in prior company stock). (or at least those are the two places it made my life miserable.)

I dont understand the rationale for this answer because it is inconsistent with the regs under 401(a)(9).

Reg. 1.409(a)(5)-5 A-1(e) provides: "Instead of satisfying this A-1 (the MRD requirements) the MRD requirement can be satisfied by the purchase of an annuity contract in accordance with A-4 of 1.401(a)(9)-6. A-4 of the-6 reg specifically applies to an annuity contract purchased from an insurance co which is used to provide distributions. In otherwords unless the participant's benefits are paid from an annuity contract (see Q-4 of the -6 reg) or a DB plan the MRD is paid under the rules of IRC 401(a)(9), not IRC 72.

In addition Reg. 1.401(a)(9)-1 Q-2 provides: " In general. The distribution rules of section 401(a)(9) apply to all account balances in existance on or after January 1,1985." I do not seen any reference to the application of IRC 72.

[masteff]

I dont understand the rationale for this answer because it is inconsistent with the regs under 401(a)(9).

Reg. 1.409(a)(5)-5 A-1(e) provides: "Instead of satisfying this A-1 (the MRD requirements) the MRD requirement can be satisfied by the purchase of an annuity contract in accordance with A-4 of 1.401(a)(9)-6. A-4 of the-6 reg specifically applies to an annuity contract purchased from an insurance co which is used to provide distributions. In otherwords unless the participant's benefits are paid from an annuity contract (see Q-4 of the -6 reg) or a DB plan the MRD is paid under the rules of IRC 401(a)(9), not IRC 72.

In addition Reg. 1.401(a)(9)-1 Q-2 provides: " In general. The distribution rules of section 401(a)(9) apply to all account balances in existance on or after January 1,1985." I do not seen any reference to the application of IRC 72.

mjb - I would have loved to have you to help argue this w/ Fidelity a number of years ago when it came up. As I stated above, I disagree w/ the notion that an MRD is an annuitized stream of payments (despite the methodology used to calculate it). My main point for bringing it up was so Tom and others (yourself included) could see that some have taken that position (or at least did as of a few years ago). I personally think MRDs should follow the source heirarchy.

[mbozek]

I dont understand the rationale for this answer because it is inconsistent with the regs under 401(a)(9).

Reg. 1.409(a)(5)-5 A-1(e) provides: "Instead of satisfying this A-1 (the MRD requirements) the MRD requirement can be satisfied by the purchase of an annuity contract in accordance with A-4 of 1.401(a)(9)-6. A-4 of the-6 reg specifically applies to an annuity contract purchased from an insurance co which is used to provide distributions. In otherwords unless the participant's benefits are paid from an annuity contract (see Q-4 of the -6 reg) or a DB plan the MRD is paid under the rules of IRC 401(a)(9), not IRC 72.

In addition Reg. 1.401(a)(9)-1 Q-2 provides: " In general. The distribution rules of section 401(a)(9) apply to all account balances in existance on or after January 1,1985." I do not seen any reference to the application of IRC 72.

mjb - I would have loved to have you to help argue this w/ Fidelity a number of years ago when it came up. As I stated above, I disagree w/ the notion that an MRD is an annuitized stream of payments (despite the methodology used to calculate it). My main point for bringing it up was so Tom and others (yourself included) could see that some have taken that position (or at least did as of a few years ago). I personally think MRDs should follow the source heirarchy.

Been there. Done that. An MRD is an annuity payment stream only when the the funds are paid from an annuity.