Failure to Remove an RMD from a 401(k) Plan Can Be Corrected
By Shelly McKinnon, CRSP
When must a business owner or participating employee begin taking money out of a 401(k) plan?
Many plans, but not all, allow employees to delay receiving required minimum distributions (RMDs) from the plan until the year of retirement and subsequent years. An owner of more than five percent of a plan-sponsoring entity cannot delay, however, and must begin taking money out of the 401(k) plan by April 1 of the year following the year in which she attains age 70½ (also known as the required beginning date). Such person is called a “five percent owner,” no matter by how much their ownership interest exceeds five percent. .
Does the April 1 deadline apply to all subsequent years’ RMDs?
No. RMDs for all subsequent years must be taken on or before December 31. Those who delay their first RMD until April 1 of the calendar year following the year in which they attain age 70½ (or following the year that they retire, if applicable), must take a second distribution by December 31 of that same year.
What are the consequences if an RMD is not distributed timely?
For a failure to remove an RMD in a timely manner, the IRS imposes an excess accumulation penalty tax equal to 50 percent of the amount that should have been distributed but was not. This penalty tax is paid by the plan participant, who must file IRS Form 5329, Additional Taxes on Qualified Retirement Plans (Including IRAs) and Other Tax-Favored Accounts, with her federal income tax return.
Are there corrective measures?
Plan sponsors can use the IRS’ Employee Plans Compliance Resolution System (per Revenue Procedure 2018-52) to voluntarily correct the mistake of not removing RMDs. The following correction methods may be used.
Self-Correction Program (SCP)
Distribute the RMD plus earnings.
Participant will owe the IRS an excess accumulation penalty tax of 50 percent of the missed RMD amount. Participant may apply for a penalty waiver, asserting that the excess accumulation was a result of reasonable error, and that reasonable steps are being taken to remedy the excess (i.e. removing the RMD, adjusted for earnings). To apply for the waiver, a participant must attach and submit a letter of explanation with IRS Form 5329.
Plan will document how the failure occurred and put procedures in place to prevent future occurrences. (A plan may, if it so chooses, provide documentation in support of the participant’s waiver request.)
Voluntary Correction Program (VCP)
A plan that assumes responsibility for the missed RMD may use the IRS’ VCP to correct the missed RMD.
Distribute the RMD plus earnings.
Plan will request a waiver on behalf of the participant for the excess accumulation penalty tax of 50 percent on the VCP application. The IRS user fee associated with the VCP submission ranges between $1,500 and $3,500, based on plan assets.
Plan will document on the VCP application how the failure occurred and the procedures it has since put in place to prevent future occurrences.
If approved, plan will receive a compliance statement from the IRS.
Realistically, correcting RMD failures through the IRS VCP program could be significantly more expensive than the 50 percent penalty tax for a missed RMD or multiple missed RMDs. The VCP program may only be a reasonable approach if the total RMD failure is extensive in aggregate dollar amount.
It is important to note that if an RMD is not removed from the plan, the RMD amount is not eligible for rollover, even if a 50 percent excess accumulation penalty tax has been paid. If the participant takes a distribution, the first dollars that are distributed go toward satisfying the missed RMD and cannot be rolled over to an IRA or other retirement plan.