When is a partner’s required beginning date for a required minimum distribution?

For many years (and before turning 50), Jane has been, and still is, a partner in a business organization. With many partners, Jane’s capital interest and her profits interest both have been always less than 5%. Now in her 90s, Jane remains an equity partner, still has her capital interest, and gets a draw on her profits interest. Jane still performs some personal services in the business.

Assume the business organization’s individual-account retirement plan requires no more than is needed to meet § 401(a)(9) to tax-qualify.

When is Jane’s required beginning date?

If I am understanding you correctly, Jane has never been a 5% owner in any year. So her required beginning date would be April 1 of the year following the later of:

• The year in which she attains the applicable age (70½, if her date of birth was before July 1, 1949), or
• The year in which she retires from employment with the employer maintaining the plan

Since it is clear she has already attained the applicable age, the question is, has she retired? Neither Code section 401(a)(9) nor the regulations thereunder provide a definition of "retires" for this purpose.

Your question indicates that she is still performing some personal services for the business. It might be reasonable to consider her to still be an employee (and not retired) in any year in which she receives earned income (within the meaning of section 401(c)(2) of the Code), although that could be problematic if is is not known whether she received earned income until after April 1 of the following year.

Another possibly reasonable approach might be to simply ask the plan sponsor whether they consider Jane to be retired, within the common meaning of the word.

Ultimately this will be a matter of the plan administrator making a reasonable interpretation of the law and regulations.

29 minutes ago, C. B. Zeller said:

Your question indicates that she is still performing some personal services for the business. It might be reasonable to consider her to still be an employee (and not retired) in any year in which she receives earned income (within the meaning of section 401(c)(2) of the Code), although that could be problematic if is is not known whether she received earned income until after April 1 of the following year.

At least under SECURE 2.0, if a goof is made, it can be corrected with "only" a 10% penalty. Some small consolation, anyway...

And I agree that the plan sponsor should make the formal decision as to whether or not she is "retired." 

C.B. Zeller and Belgarath, thank you for helping me with a thoroughness check.

Further, a perhaps related point of tax law treats someone who has been a self-employed individual as continuing to be a self-employed individual even if a year’s earned income is zero or negative.

The term “self-employed individual” means, with respect to any taxable year, an individual who has earned income (as defined in paragraph (2)) for such taxable year. To the extent provided in regulations prescribed by the Secretary, such term also includes, for any taxable year— (i) an individual who would be a self-employed individual within the meaning of the preceding sentence but for the fact that the trade or business carried on by such individual did not have net profits for the taxable year, and (ii) an individual who has been a self-employed individual within the meaning of the preceding sentence for any prior taxable year.

I.R.C. (26 U.S.C.) § 401(c)(1)(B) http://uscode.house.gov/view.xhtml?req=(title:26%20section:401%20edition:prelim)%20OR%20(granuleid:USC-prelim-title26-section401)&f=treesort&edition=prelim&num=0&jumpTo=true.

For purposes of section 401, a self-employed individual who receives earned income from an employer during a taxable year of such employer beginning after December 31, 1962, shall be considered an employee of such employer for such taxable year. Moreover, such an individual will be considered an employee for a taxable year if he would otherwise be treated as an employee but for the fact that the employer did not have net profits for that taxable year.  . . . .

26 C.F.R. § 1.401-10(b)(1) https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFR6f8c3724b50e44d/section-1.401-10#p-1.401-10(b)(1).

Let me add some observations to the above very thoughtful analysis. Under the ECPRS and general fiduciary principles administrators of tax-qualified plans, such as the one Mr. Gulia described, should establish and maintain administrative practices and procedures to ensure that these plans are operated properly in accordance with the Code’s qualification requirements. Those requirements include the requirement that such plans make the Code §401(a)(9) required minimum distributions. 

Thus, qualified plan administrator should have a procedure in place to determine annually which plan participants, if any, are required to receive RMDs and to make distributions to any such individuals. This procedure should include verifying whether any participants are in excess of the applicable RMD age, which as Mr. Zeller observes depends on the participant’s birthday.

If the plan provides that payments are made regardless of whether the participant retires, the administrator must act to make such payments to comply with the plan terms, which is also a plan qualification requirement.  Such plan provisions do not violate Code §401(a)(9).  If the plan provides, as described above, that the plan payments need not be made until the participant retires, there would have to be another plan provision providing that payments must begin to be made at the applicable RMD age if the participant was a 5-percent owner in such year. The plan administrator would then have to determine if this exception governs.

Many plans, however, take an intermediate approach and provide that plan distributions must begin on the April 1 following the year in which the participant reaches age 70.5¹ regardless of whether the employee has retirement. Otherwise, IRC § 401(a)(9)(C)(iii) requires that the annual benefit be increased to the actuarial equivalent of the benefit that was accrued as of the date the employee attained age 70.5.  There may be tax qualification issues with plans allows such increases without limit. In particular, IRC § 401(a)(16) prohibits annual benefits in excess of the Code §415(b) limits of 100% of the participant’s high average compensation.  Thus, the administrator may wish to compare Jane’s annual plan benefit with her high average compensation.                                  

¹ To avoid actuarial equivalent increases, the payments would have had to begin on January 1, 1997, if the employee attained 70.5 prior to January 1, 1997. See Treas. Reg. §1.401(a)(9)-6-A-7).

Best wishes,

                                    Albert

My remarks about actuarial equivalents only apply to defined benefit plans.  There is no similar provision for defined contribution plans which also need not worry about qualification failures stemming from excessive benefit distributions

Some prior commentary from the Gray Book:

QUESTION 1999-21, Other DB Issues: Definition of Retirement or Termination of Employment
A number of qualified plan rules hinge on a participant's retirement status. Examples include the ability to receive a benefit distribution prior to separation from employment and the requirement to commence distributions at the later of age 70 1/2 or retirement.  How are these requirements addressed for participants who view themselves as "semi-retired" or "retired, supplementing pension with part-time work for the same employer"? Would application of such rules hinge on discretionary elections made by the employee (as opposed to the employer)?

RESPONSE
The §401(a)(9) guidance did not address what constituted retirement. Once the status of worker changes from common law employee of the employer sponsoring the plan, the employee has retired.  Other situations will be addressed on a case-by-case basis.  Not having enough hours of service to trigger the suspension of benefit service rules is not sufficient to be considered retired.  For purposes of the minimum distribution requirement, once the employee has had a bona fide quit, any subsequent re-employment with the same employer does not allow for further delay of the minimum distribution requirement.

Similarly, re-employment does not inhibit the ability to permit a distribution on account of "separation from service" based on the earlier termination of employment. 

QUESTION 2004-42, Other DB Plan Issues: Date of Retirement and Required Minimum Distributions
Treas. Reg. §1.401(a)(9)-2, A-2(a) provides that except in the case of a 5%-owner, the “required beginning date” is April 1 of the calendar year following the later of the calendar year in which the employee attains age 70-1/2 or the calendar year in which the employee retires from employment with the employer maintaining the plan.

If December 31, 2003 is the employee’s last day at work, and the last day for which he is paid or entitled to payment of wages, is that the date of “retirement”.  Or is January 1, 2004, the first day he is not employed, the retirement date?  When is the employee’s required beginning date?

RESPONSE
“Retirement” is the last day worked, not the definition of retirement date in the plan.  What date is an employee’s last day worked is a facts and circumstances determination.  The facts and circumstances are based on the employer’s practice concerning the last day an individual is considered an employee.