Missed RMD by TPA

Just received this question from a CPA friend.  One of his tax client who was a 5% owner in a small consulting firm (about 5 years back) and then reduced his ownership to 2% later.

He received RMD while he was a 5% owner.  Since then he never received any RMD from the plan (for 5 years).  Recently he received a letter from the TPA that he missed taking his RMD for the past 5 years and they will be processing all of his RMDs and he will owe taxes and penalties (for failure to take RMD) as well as the TPA has told this participant that the plan now has a compliance failure and that needs to be corrected and said that they (the TPA) will bill him about $5,000 for the filing fee + TPAs fee.  What should be the response by the participant.

I'm a little confused by the timeline.

Has it always been the same TPA?

What does the TPA service agreement with the client say?

Is the Participant being asked to pay the Plan Sponsor's VCP submission fee?

If I'm the participant my response is here is my lawyer's phone number.

My understanding is that it is the same TPA.  Yes, TPA is blaming the participant for failure to withdraw RMD in a timely manner.  I have instructed the CPA to get the service agreement with TPA as well as plan AA.  Once I gather more information will post the details.

I am confused too, didn't the TPA provide the client with the RMD amount each year? Or, did they actually expect the client to determine his own RMD for a pension plan and withdraw?

If the TPA provided the info and the client did not take it out after one year, did they inform the client about the issues? 5 years in a row is a bit too much of a stretch for not informing the client each year and continue administering the plan as if nothing is wrong. Hmmmm.

Moreover, when the TPA did the annual work, didn't they notice that there were withdrawals missing?

May be I am not reading the original post correctly!

Just a guess. These are individual brokerage accounts for each participant, the guy who didn't take the RMD used to be the head hancho at the company and his golf buddy broker told him he didn't need RMDs because he's not a 5% owner anymore?

But yeah as Jakyasar says, something doesn't sound right here.

But 5 years in a row and TPA does not know about the account activity? I still think it is quite a stretch unless the participant never disclosed the account (happens, right?)

We are missing information, that's for sure.  The problem with SDBA as a TPA is that you have to rely on a trustee or sometimes participant to act.  

SECURE 2.0 will have to be reviewed to see if this is now a self-correction.  HCE failing to take taxable income for 5 years may still require filing versus TPA admitting it misapplied the law and never notified him.

Can't add much.  As at least one other has said: (1) take a look at the TPA agreement; and (2) assuming that lots of money  is involved, the participant should speak with an attorney who specializes in ERISA matters.  More facts would help, too.  Off hand, it sounds like this is more a participant failure than a TPA failure, but the TPA agreement may tell a different story.  And, even if the result is pretty clearly a TPA failure, the participant may need an attorney to help resolve (again, assuming the money involved makes the attorney's fee worth it.

SECURE 2.0 may have some reduced penalty but only if corrected within 2 years.

Looks like, the first 3 years is out of luck, at least from I understand. Depending on facts and circumstances, can always go to the IRS, cry and blame someone that the participant was not aware of not was notified, etc etc etc.

Do not know all the details, just a general info.

First, what type of plan is this?  Recall that during Covid, DC plans were permitted to suspend RMDs whereas DB plans were not.  Is it possible that is why he stopped and never restarted?  Or even worse did he have a DB plan and stop?  I cannot tell you how many investment managers told our DB participants they didn't need to take their distributions during Covid.  One HCE did just that and got caught during the plan termination.  I'm sure your ex-HCE didn't just wake up one day and say I'm no longer an HCE so I'll stop taking my RMDs.  Someone told him this.  That person needs to be liable.  Typically all professionals have liability insurance. 

Also, can anyone just stop receiving their RMDs?  Seriously, if I am no longer working and begin getting RMDs and then am hired after a couple years, can I stop the payments?  I really don't think this is permitted and would be surprised if a status change from HCE to non-HCE would change the distribution amount.  Having said this, he absolutely needs an attorney.  That was our advice to the HCE that was caught and the investment advisor had to pay the fines.

If the plan has a tax-qualification failure to correct, does SECURE 2022 § 305 [attached and highlighted below] expand some opportunities for a correction?

To get the protection of this new law, one must correct an eligible inadvertent failure promptly after it is discovered.

But is there a time limit on failures otherwise eligible to be corrected?

This section of the statute became effective on December 29, 2022.

self-correction of eligible inadvertent failure.pdf

Maybe Peter but in this particular case it might be hard to argue the inadvertent part for someone who was a 5% owner who had been taking RMDs and then for some reason seems to have stopped "about 5 years ago" as the OP puts in their post.

Your highlighted text is interesting. As for what the IRS will deem a reasonable time frame in practice I can't say for sure but looking toward existing current guidance on the IRS self correction program it seems like correction within 2 years would be deemed reasonable. Beyond that might get into some gray areas on reasonableness. Maybe the IRS will use one of their ever popular facts and circumstances approach unless they publish a bright line deadline in future guidance or maybe they will deem any self correction that is done is done in a reasonable time frame.

The “reasonable period” does not refer to how long the failure remained undiscovered. Rather, it’s about how promptly the failure is self-corrected “after such failure is identified.”

SECURE 2022 § 305 undoes the Internal Revenue Service’s time limit on which failures are eligible (if otherwise eligible) for self-correction.

Congress’s statute provides no special definition for the word “inadvertent”.

Merriam-Webster says inadvertent means unintentional or inattentive. https://www.merriam-webster.com/dictionary/inadvertent

In VirtualTPA’s story, one might imagine the plan’s tax-qualification failure could have resulted from its administrator’s unintentional or inattentive lack of knowledge of the plan’s provisions. (Isn’t that a way many failures happen?) The administrator (the one responsible under ERISA and the tax Code, not the TPA) might not have known the plan compels an involuntary minimum distribution to a participant who was at a relevant time a more-than-5% owner.

(I observe nothing about how responsibilities sort out between and among the participant, the administrator, and the third-person service provider.)

If the Internal Revenue Service later pursues something under the IRS’s finding that a plan was tax-disqualified and not self-corrected, whoever asserts the failure was self-corrected must persuade a finder of law and fact that the failure was eligible for self-correction.

One can imagine at least plausible, and perhaps persuasive, arguments that a failure of a kind VirtualTPA’s story describes was inadvertent. If it was, the passing of a few or many years does not by itself make a failure that otherwise was inadvertent necessarily less so. A plan’s administrator that errs by not knowing the plan’s provision that applies to a participant who was a more-than-5% owner might continue its ignorance for years or decades. Likewise, inattentiveness too sometimes persists over stretches of time.

I concede there is a separate problem about whether the plan’s administrator had procedures reasonably designed to cause the administrator to administer the plan correctly. If an organization really wants rules obeyed, one must supplement written procedures with compensating controls designed under an assumption that some or many people won’t read the written procedures they are told to follow, especially if the rules are many or complex (or, worse, both). But I’ve never seen the IRS push such a point. Instead, the IRS treats the procedures condition as met, even if everyone strongly suspects no one read the procedures.

We’re not getting the full facts of the story. If we had them, there could be a discussion about whether the failure was inadvertent, not egregious, and otherwise fits conditions for a failure that could be a subject of self-correction.

But that a failure happened more than two or three years ago does not by itself make the failure ineligible for self-correction.