Failing to Remove an RMD from a 401(k) Plan Can Be Corrected
By Shelly McKinnon, QKA, TGPC, CRSP, CIP, CHSP
When must a business owner begin taking money out of his 401(k) plan?
An owner must begin taking money out of her 401(k) plan by April 1 of the year following the year in which she attains age 73 (also known as the owner’s required beginning date). The minimum amount that must be taken out for a given tax year is called the required minimum distribution (RMD). An “owner’ is an individual who owns more than five percent of the business for which the plan is established. (If a plan permits, an individual who owns a smaller percentage or is a nonowner of RMD age may wait until they retire from the plan-sponsoring employer to begin taking RMDs.)
Does the April 1 deadline apply to all subsequent years’ RMDs?
No. An owner must take his RMD for subsequent years on or before December 31. This means that owners who delay their first RMDs until April 1 of the calendar year following the year in which they attain age 73, must take a second distribution by December 31 of that same year.
What are the consequences if an RMD is not distributed timely?
If an RMD is not removed in a timely manner, the IRS will impose an excess accumulation penalty tax equal to 25 percent of the amount that should have been distributed but was not. If a failure to take the RMD is corrected in a timely manner, the penalty tax on the failure may be reduced to 10 percent. To qualify for the reduced 10 percent penalty tax, the RMD must be satisfied during a specified correction window, which begins on the date the penalty tax is imposed and ends the earlier of
the date that a notice of tax deficiency is mailed;
the date that the penalty tax is assessed (i.e., recorded); or
the last day of the second taxable year beginning after the year in which the penalty tax is imposed (i.e., applied).
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 Employee Plans Compliance Resolution System (under Revenue Procedure 2021-30) to voluntarily correct the mistake of not removing RMDs. Following are correction methods that may be used.
Self-Correction Program (SCP)
Distribute the RMD plus earnings.
The participant will owe the IRS an excess accumulation penalty tax. The participant may apply for a penalty tax waiver if he can prove that the excess accumulation was a result of reasonable error, and reasonable steps are being taken to remedy the excess (i.e., removing the RMD as adjusted for earnings). To apply for the waiver, the participant must attach a letter of explanation with IRS Form 5329.
The plan sponsor will self-document how the failure occurred and put procedures in place to prevent future occurrences.
Voluntary Correction Program (VCP)
A plan sponsor that assumes responsibility for the missed RMD may use the IRS’ VCP to correct the missed RMD.
Distribute the RMD plus earnings.
The plan sponsor will request a waiver on behalf of the participant for the excess accumulation penalty tax on the VCP application. The IRS user fee associated with the VCP submission ranges between $1,500 and $3,500 based on plan assets.
The plan sponsor will document on the VCP application how the failure occurred and the procedures in place to prevent future occurrences.
If approved, the plan sponsor will receive a compliance statement from the IRS.
It is important to note that if the RMD is not removed from the plan, the RMD amount is not eligible for rollover. 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.
