RMD Evolution: Part 2
We covered the history and statutory framework of required minimum distributions and the increase in the triggering age for RMDs in Part 1 of 3 of our SECURE 2.0 RMD blogposts. We will cover the changes to rules on annuities to promote lifetime income distribution options in a future blogpost. In this post, we discuss a potpourri of changes made to the RMD rules, including the reduction in excise taxes for failure to make timely distributions, elimination of distribution requirements for certain Roth accounts, and the new election available for surviving spouses. Although these changes add further nuances to rules that are already complex, these changes are certainly welcome by plan participants and beneficiaries. The Roth and surviving spouse amendments will give certain participants and beneficiaries the ability to defer distributions longer on a portion of their account balances, and the reduction in excise taxes will reduce future participant liabilities and may change plan administrator calculations when determining the best way to correct RMD failures.
Excise Tax Reduction
Effective January 1, 2023, the excise tax assessed on participants for failure to make required minimum distributions will decrease. Prior to SECURE 2.0, an RMD failure would subject a participant to a 50% excise tax on the missed amount, and because 401(a)(9) is a qualification requirement, the plan could be subject to disqualification unless corrective action was taken. Participants subject to the excise tax would report the excise tax through an IRS Form, but could seek a waiver for reasonable cause. Plans can correct the qualification failure through EPCRS self-correction or voluntary correction programs.
SECURE 2.0 reduces the excise tax to 25%, and where an underpayment is corrected within a window that generally ends on the last day of the second taxable year following the year of the failure, reduces the excise tax to 10% (e.g., if the excise tax is imposed for failure to receive an RMD in 2023, the correction window for the reduced 10% excise tax would end December 31, 2025). To qualify for the reduced excise tax, a distribution and return must be filed within the correction window.
We often see plan sponsors want to make participants whole when RMD failures are outside of the participant’s control. Prior to the SECURE 2.0, this was done almost exclusively by requesting a waiver on behalf of the participant through filing a VCP application. The plan sponsor could directly compensate a participant for the amount of excise tax due, but not only does this put the onus on the participant to correct, but the VCP application was often cheaper. Although VCP has a user fee (ranging from $1,500 to $3,500), the program enables a plan to request a waiver of participant excise taxes in addition to the plan correction. The reduced excise tax might alter plan sponsor calculations, and it could make more sense to correct without utilizing VCP in more scenarios with the reduced excise taxes. However, plan sponsors have to consider that a contribution to a participant to pay the excise tax will be subject to income tax, and therefore would have to be grossed up to make the participant whole. In addition, it is common for RMD failures to include more than one participant, and we expect the one-time VCP application fee to still be cheaper than making direct payments to participants in many scenarios.
Effective for taxable years beginning January 1, 2024, participants no longer have to take RMDs from their defined contribution Roth accounts before their death. RMDs would trigger on Roth accounts only after the death of the participant. After the participant’s death, the participant would be treated as having died before the RBD for purposes of calculating RMDs from designated Roth account, regardless of age or retirement status. This new rule for qualified defined contribution plans is similar to the RMD rules for IRAs that were in effect prior to SECURE 2.0. The 2024 effective date means that 2023 RMDs due in 2023 or before April 1, 2024 must still be paid on Roth accounts. We are waiting on guidance on whether a participant who commenced RMDs before 2024 may stop taking RMDs on Roth accounts after the effective date, and are hopeful that the IRS will provide clarification on this issue.
Prior to SECURE 2.0, a surviving spouse was treated as a designated beneficiary of the participant. Effective for calendar years beginning January 1, 2024, a special rule for a surviving spouse of an employee was added to section 401(a)(9) of the Code that will permit a surviving spouse to elect to be treated as if the surviving spouse were the employee. Surviving spouses might make such an election for two reasons: (1) such an election would permit the surviving spouse to have their distributions determined using the uniform life table rather than the single life table (i.e., permits RMDs to be made over a longer distribution period, therefore permitting the spouse to defer the amount of distributions for a longer time); and (2) if elected and the surviving spouse dies before RMDs to such spouse begin, the RMD rules shall be applied as if the surviving spouse is the employee (i.e., potentially extending distributions for beneficiaries of the surviving spouse). It is not clear if this new rule is required or an optional provision that plans may adopt, but we are hopeful that guidance will be issued prior to the 2024 effective date.
As a reminder, plan amendments for most plans are not due for the SECURE Act or 2.0 until the end of the 2025 plan year, but plans must comply with the new laws in operation prior to the amendment deadline. We are hopeful that guidance will be issued before the effective dates on the Roth and surviving spouse provisions, and we will continue to provide updates when available. If you have any questions on any of the changes made by the SECURE Act, SECURE 2.0, required amendments, subsequent IRS guidance, or administering RMDs, please contact any of the attorneys in our Employee Benefits Group.