The Who-What-When-Where-Why-and-How of RMDs

The April 1 RMD deadline is soon approaching! At this time of year, it’s a good idea to make sure you are familiar with the RMD requirements. This article will give you a quick overview of the 5 W’s of RMDs for most types of retirement plans.

Who needs to know about RMDs?

Anyone who has a tax-advantaged retirement account of any kind - including an IRA, 401(k), profit sharing plan, 403(b), defined benefit pension plan, and more - needs to be aware of the Required Minimum Distribution (RMD) rules.

Beneficiaries of deceased plan participants are also subject to RMDs, however those rules will not be covered in this article.

What even is an RMD?

Congress enacted tax-advantaged retirement accounts to help American workers save for retirement. The intention is that the amounts accumulated in those accounts will actually be used to support the individual during retirement, and not as an estate planning tool or a vehicle for transferring an inheritance to one’s heirs. Therefore the law requires that retirement accounts begin to be distributed at a certain time.

Why do I need to be aware of RMDs?

Failure to take an RMD when it is due can result in penalties up to 25% of the amount that was not taken.

When do I need to take an RMD?

Your first RMD from any retirement account must generally be taken no later than April 1 of the year following the year in which you reach age 73. This age was just increased from 72 to 73 by the SECURE 2.0 Act, and as a result 2023 is a transition year. In other words, anyone who turned 73 in 2023 would have been subject to the age 72 rule, and because they turned age 72 in 2022 they already had to take their first RMD by April 1, 2023. If you turn 73 in 2024, then your first RMD will be due by April 1, 2025.

For employer-sponsored plans (including 401(k) plans, 403(b) plans, 457(b) plans and defined benefit plans), you may generally postpone your first RMD until April 1 of the year after you actually retire from employment with that employer.

Putting these together, someone who turned age 72 in 2022 but didn’t retire until 2023 would have to take an RMD from their IRA by April 1, 2023, but could wait to take an RMD from their 401(k) until April 1, 2024.

After the first RMD, additional RMDs are due by December 31 of each year. If the first RMD is taken on or before April 1 of the calendar year following the year in which the employee reaches age 73 (or retires), then two RMDs will be due during that calendar year - one by April 1, and another by December 31.

Where do I need to take my RMD from?

All traditional (pre-tax) plans and IRAs must comply with the RMD rules. Roth IRAs and Roth accounts in 401(k), 403(b) and governmental 457(b) plans are excluded from RMDs.

If you have more than one IRA, you may treat all of them as a single IRA for RMD purposes. What that means is that while you must calculate the amount of your total RMD taking into account the balances in all of your IRAs, you may take the amount of the RMD as a distribution from just one account or some of the accounts.

The same aggregation rule applies to 403(b) plans, so if you were a participant in more than one 403(b) plan, you can take your entire RMD from just one 403(b) or split it among them.

Qualified plans (including 401(k), profit sharing, and defined benefit plans) must each separately satisfy the RMD rules. So if you have more than one 401(k) account, you need to take an RMD from each of them.

How much is my RMD?

For account-type plans (including all 401(k) plans, 403(b) plans, and IRAs) the amount of the RMD is equal to the account balance at the previous December 31 divided by a life expectancy factor. For a first RMD that is due April 1, it is technically considered to be on behalf of the previous year. So the account value used is the account value at December 31 two years ago (for example, an RMD due April 1, 2024 would be based on the December 31, 2022 account balance).

For defined benefit plans the amount is determined differently. This includes cash balance plans - the “hypothetical account balance” is not a real account balance for this purpose. In a defined benefit plan, the payment of the entire accrued benefit must commence by the required beginning date. Defined benefit plans can offer multiple optional ways for the benefit to be paid out, including a single life annuity, a joint & survivor annuity, a term certain & life annuity, a single sum payment, and more. Any of these can satisfy the RMD requirement. However, taking partial withdrawals (as in account balance-type plans) does not satisfy the requirement.

Non-governmental 457(b) plans have a special rule that the distribution becomes taxable when it becomes available to the participant, regardless of whether they actually take the distribution or not. Since participants in these plans are required to make an advance election as to how and when to receive their distribution, it is important that they actually take the money at the time elected, since they will be taxed on it regardless.

Force Outs Under SECURE 2.0

As seen in our 2023 EOY Newsletter: Click Here

Corey Zeller, MSEA, CPC, QPA, QKA

When an employee leaves their employer, they may have a balance in their employer’s 401(k) plan, profit sharing plan, or other qualified retirement plan. In general, they would have the right to take their money out of the plan upon separation of employment, but in most cases they also have the right to leave their money in the plan.

Sometimes the amount left behind will be small, particularly if the employee was not a participant in the plan for a long time. To avoid accumulating a large number of small balances, plans are allowed to “force out” the accounts of former employees with vested balances below a certain dollar threshold, meaning that these small balances can be distributed without the participant’s consent. When force outs were first added to the law, the limit was $3,500. It was increased to $5,000 by the Taxpayer Relief Act of 1997, and most recently it was increased to $7,000 by SECURE 2.0, effective starting in 2024.

The increase in the force out limit is advantageous for plans that prefer to force out former employees with small balances, since it will allow more former employees to be forced out. In order to take advantage of the change, the plan document must be amended to reflect the increased force out limit. In most cases, if the plan document already had the $5,000 force out limit prior to 2024, it would be automatically increased to $7,000 starting in 2024. However, if the plan had a lower force out limit, or did not allow force outs, then an explicit amendment would be needed.

This change is also welcome news for plans that are subject to Qualified Joint & Survivor Annuity (QJSA) rules. This includes all defined benefit plans and money purchase plans, as well as certain profit sharing plans and 401(k) plans. Amounts less than the force out limit may be distributed to the participant in a single sum without spousal consent.

In addition, the force out dollar limit is used to determine whether a distribution from a defined benefit plan would be restricted by the plan’s funded status. This includes both the AFTAP-based restrictions of IRC sec. 436 as well as the “110% rule” of Treas. Reg. 1.401(a)(4)-5(b).

It’s important to note that if a plan provides for force outs, they are not considered to be optional. The plan document language that has been approved by the IRS says that former employees with a vested balance less than the limit “will” be forced out. In the past, the IRS has ruled that a failure to consistently apply a plan’s force out provisions will result in those provisions being treated as invalid. Thus, the plan could lose its ability to force out former employees entirely. Therefore, it’s important to regularly force out former employees. It’s not just to keep the plan accounts clean, it’s also for compliance.

Automatic Enrollment Under SECURE 2.0

As seen in our 2023 EOY Newsletter: Click Here

Kristin Tocket, CPC, QPA, QKA, TGPC

One of the many changes under SECURE 2.0 is the expansion of automatic enrollment in 401(k) and 403(b) plans.  With automatic enrollment, employers will automatically withhold employee contributions at a default rate from eligible employees’ wages. To avoid being automatically enrolled, eligible employees must affirmatively make a deferral election, or choose not to participate.  If they do not take any action, they are enrolled at the plan's default rate.

Prior to the enactment of SECURE 2.0, automatic enrollment was an optional feature in retirement plans. However, with these recent changes, most plans established after December 29, 2022 will be required to implement automatic enrollment for plan years beginning in 2025. The following are exempt from the mandate:

• Small businesses with 10 or fewer employees

•  New businesses (those that have been in business for less than 3 years)

• Church Plans

• Governmental Plans

• 401(k) and 403(b) plans that were established prior to December 29, 2022

To meet the requirements under SECURE 2.0, sponsors must implement an Eligible Automatic Contribution Arrangement (EACA) that would include the below features:

• Initial default contribution rate of a least 3% but no more than 10%

• The default contribution rate must automatically increase by 1% each year until the rate reaches at least 10%, but no more than 15%

• 90-day permissive withdrawal feature (participants are allowed to withdraw any contributions made under the automatic enrollment feature within 90 days)

Participants who are automatically enrolled must be invested in a vehicle that meets the DOL’s requirements for a  Qualified Default Investment Alternative (QDIA)

Employer contributions are not mandatory with an EACA unless the plan document indicates otherwise, such as a safe harbor contribution or a fixed matching contribution. If an employer intends on sponsoring a Safe Harbor plan, they should consider utilizing a Qualified Automatic Enrollment Arrangement (QACA), as opposed to an EACA. While a QACA must meet the same requirements as listed above, these plans can utilize a reduced match formula as compared to a traditional safe harbor match, as well as requiring up to two years of service to become vested.

For more information on adding an automatic enrollment feature to your plan, or any other plan design questions, please contact your plan consultant.