Required minimum distributions (RMDs) may not come up often in retirement plan operations. When they do, it can be a real pain in the administration. The RMD rules can be complicated with exceptions to the exceptions, and recent law changes just added to the complexity.
Wouldn’t it be great if retirement plans didn’t have to worry about RMDs? They don’t.
Retirement plans can forgo the RMD chaos altogether by using the plan’s force-out provisions and automatic rollover IRAs for terminated participants at normal retirement age (NRA). Before we discuss how to avoid RMDs, we provide some motivation by detailing how RMDs have recently become more burdensome. In understanding these new complexities, it may be time to seriously consider using force-outs at NRA.
Increased Complexity of RMDs
Retirement plans were not intended to be estate planning mechanisms. Their purpose is to have sufficient funds to help individuals be financially secure when they are no longer working. To ensure participants are using their retirement benefits – or at least being taxed on them – the RMD process has been around since the passage of ERISA. A simple concept has increasingly become an operational nightmare.
Commencement of RMDs
There used to be one age for beginning RMDs, age 70 ½. With the recent passage of SECURE and SECURE 2.0, RMDs may start at one of four(!) different ages depending upon the participant’s birth year.
| Birth Year | RMD Age |
|---|---|
| Born before 7/1/1949 | 70 1/2 |
| Born after 6/30/1949 and before 1/1/1951 | 72 |
| Born in 1951 through 1959 | 73 |
| Born after 1959 | 75 |
There is an exception to starting RMDs at this time if the participant is still working at the applicable age. However, there is an exception to the exception for more than 5% owners of the business. Those individuals cannot wait until termination of employment. They must commence RMDs at the RMD age regardless of employment status.
RMD Payments Upon Death
Prior to SECURE (the initial one, not 2.0), beneficiaries generally had the ability to stretch out RMD payments for their lifetime. For participants dying after 2019, only “eligible” beneficiaries can receive lifetime RMD payments upon the participant’s death. An “eligible” beneficiary is defined as the participant’s:
- Spouse
- Child under the age of 21
- Beneficiary who is no more than 10 years younger than the participant
- Beneficiary who is disabled or chronically ill
If the plan allows for lifetime RMD payments upon death, the administrator will need to verify that the beneficiary meets this “eligible” definition, including specific parameters of whether the beneficiary is disabled or chronically ill.
Payment Term if Not “Eligible” Beneficiary
Beneficiaries not meeting the “eligible” definition above will need to be paid the full account balance within 10 years. Although this seems straightforward, there are exceptions:
- If RMDs have already begun to the participant before death, a portion of the balance “may” need to be paid annually although the full amount doesn’t need to be paid until the end of the 10-year period. The word “may” is in quotes because the IRS has yet to confirm its interpretation of this requirement. See IRS Notice 2023-54.
- When a child reaches age 21 they can no longer receive lifetime RMD payments. The 10-year period begins at age 21, and the remaining account balance must be paid before the end of that period.
- If a trust or the participant’s estate is listed as the beneficiary, the full account balance must be paid before the end of a five-year period instead of 10 (another exception to an exception).
Failure to comply with these payment terms or any RMD requirement could result in the participant or beneficiary being liable for an excise tax up to 25% of the affected amount.
Force-Out Distributions at NRA
If your head spins just thinking about the RMD process, then eliminate it. Retirement plans can force-out participants who have terminated employment if they don’t take their account balance by the plan’s defined normal retirement age (NRA).
Force-Outs Aren’t Just For Small Balances
Everyone knows about force-out provisions for terminated participants with a balance of less than $7,000. That same process can also apply to terminated participants who reach normal retirement age. The reason is that participant consent is only required for any distribution before the participant attains the plan’s normal retirement age (or age 62, if later).
To illustrate, Mike left his employer at age 55. He received the distribution notice and election forms but decided to keep his money in the employer’s plan. When Mike attains the plan’s NRA of 65, he would again receive a distribution notice and election form; this time stating that failure to make an election will result in a force-out distribution. If Mike fails to timely complete the second election form, then a force-out distribution occurs.
Although the force-out distribution is not required to be sent to an automatic rollover IRA, using an auto rollover IRA can be beneficial to both the plan sponsor and the service provider. The benefits are similar to ones detailed in my previous blog “Prevent Problems By Using Auto Rollover IRAs for Force-Outs Below $1,000.”
Getting Started with Force-Outs at NRA
If you and your plan sponsors are on board with force-outs at NRA to avoid the burden and cost of the entire RMD process, the next question is: “What’s next?” The answer is most likely a plan amendment. Even though the law only requires participant consent up to NRA, many pre-approved plan documents default to always requiring participant consent before making distributions for balances above $7,000 – at least until RMDs begin.
Consequently, a plan amendment may be needed to change the ability to force-out terminated participants at the plan’s NRA. Moreover, the amendment can be effective for all participants, both former and current employees, along with all existing account balances. In other words, there does not appear to be a protected benefit issue. The IRS appears to exempt the use of force-out distributions at NRA from the anti-cutback rule. See Treas. Reg. 1.411(d)-4 and Q&A 2(b)(v).
Potential Downsides to Force-Outs at NRA
Yes, force-outs at NRA alleviate the RMD complexity, but there may be other factors to consider.
First, like force-outs of small balances, these provisions must be applied consistently to all participants. The business owner’s balance can’t be left in the plan after NRA while all other participants are forced out at NRA. Second, some participants, especially business owners, may use the retirement plan as an extra layer of protection from bankruptcy or judgment creditors.
Some plan sponsors may believe it is unfair to force out terminated participants at NRA. However, whether through affirmative election or use of an auto rollover IRA, individuals may have certain advantages in having their assets in an IRA. For example, the expanded choice of investments may better suit their circumstances, including potential retirement income options. The use of an IRA may also provide additional flexibility in how RMDs are eventually processed.
All of these factors should be considered in determining the best course of action.
Prevent RMDs From Being a Pain in the Administration
“I love working with RMDs,” said no one. Using force-out distributions and automatic rollover IRAs for terminated participants at NRA allows you and your plan sponsors to avoid RMD complexity.
RMDs have become more burdensome lately, especially with different RMD ages, revised payment terms and defining “eligible” beneficiaries. In considering the burden and potential for error, it may be time to prevent this unnecessary time and expense on RMDs by using force-outs at NRA. You may only be a plan amendment away from forgoing the madness.
About The Author
Brian Furgala is Senior Director, Retirement Services Strategy for PenChecks Trust®, a leader in outsourced retirement plan distribution processing and Automatic Rollover/Missing Participant IRAs and related services. His broad experience as an ERISA attorney and senior executive for several leading retirement plan service providers gives him a unique perspective on the industry.
The views expressed in this article are those of the author and do not necessarily represent the views of PenChecks Trust®, its subsidiaries or affiliates.
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