Required Minimum Distributions (RMDs) – The Out of Sight, Out of Mind Problem

We all sometimes lose track of things hidden away in the back of the closet or fail to stay in touch with friends we haven’t heard from or seen in a while. These common tendencies can cause inconvenience in our everyday lives — but may lead to catastrophic failures when it’s our pension requirements that are out of sight, out of mind. Susceptible to this phenomenon are many tax-qualified pension plans, particularly in the public sector, that must comply with the required minimum distribution, or RMD, rules. These are the tax rules that, among other things, generally require participants to commence or receive their benefits by no later than the April 1st following their attainment of age 70½, if they are no longer working.

If the RMD rules are not followed, both the participant and the employer may be subjected to significant penalties and problems. If this is the case, why would any participant fail to receive (or at least start to receive) their benefits?

  1. Unfortunately, we see too many plans where the RMD rules and requirements are not laid out in detail, but instead “incorporated by reference.” In other words, tucked away in the back of the plan is a paragraph or two that refers to “compliance with the requirements of Code section 401(a)(9).” So, unless the HR department is familiar with these Code references and their significance, there is no way they can properly understand and administer their organization’s plan(s). While this practice is widespread, it is not advisable. Many clients simply do not understand that this simple reference is shorthand for well over 30 pages of detailed and complex regulations.
  2. RMD compliance would not be a problem if plans simply paid out benefits (to the extent vested) when participants terminate employment. However, many — if not most — defined benefit pension plans are designed not to pay out full retirement benefits until participants attain a later than normal retirement age (typically 65) or an early retirement age (typically 55). That means if a participant leaves employment at age 47, he or she may have to wait anywhere from eight to 18 years to get his/her retirement benefit. That’s the “out of sight, out of mind” conundrum – both from the employer’s perspective and the former employee’s perspective. Both forget that there is something important to follow-up on. Furthermore, many public sector tax-qualified retirement plans do not take advantage of the rules that may allow them to commence the payment of benefits once the former employee terminates employment.
  3. Even if you and your data systems are good enough to “remember” to monitor a participant’s theoretical required beginning date, how good are you at keeping track of participants’ and former employees’ addresses and emails for periods of as long as 25 to 30 years? We are finding that a huge problem with plans that defer payment for many years is their ability to locate participants to make payment. Recently, the IRS provided helpful guidance for plans undergoing IRS audits stating that it would not challenge a qualified plan for violation of the RMD requirements to commence or make distribution to a participant or beneficiary that was “missing,” provided that the plan had:
        • searched plan, sponsor and publicly available records and directories for alternative contact information
        • used a commercial locator service, a credit reporting agency, or a proprietary Internet search tool for locating individuals and
        • attempted contact via the U.S. Postal Service certified mail to the last known address and through appropriate means for any addresses or contact information on file (including email and telephone).

The “big picture” takeaways are:

  • Do you understand all of the shorthand references in your plan documents?
  • Are your plan administration systems and capabilities consistent with the design and needs of your plan?
  • Have you properly attempted to contact participants you have not heard from?
  • Should you consider adding some form of the IRS guidelines to you plan?
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