Persons who would be required to receive mandatory payments from a retirement plan or IRA in 2009 may opt not to receive the minimum required distribution for 2009. The Worker, Retiree and Employer Recovery Act of 2008, passed into law on Dec. 23, 2008, included this relief, which means that the previously required 2009 distribution does not have to be made, thereby deferring taxes on such amount. Importantly, this relief also means that no investments have to be sold in order to make the distribution.
This advisory provides an overview of the tax relief the Act provides for both employers and retirees, and includes steps they can take to ensure they make the best use of this opportunity.
What Is a Minimum Required Distribution?
When workers reach age 70 ½ after retirement, or retire after age 70 ½, they must begin receiving minimum payments from their retirement plans. Five-percent owners of a business must begin receiving payments at age 70 ½ even if they have not retired. Owners of individual retirement accounts (IRAs) must begin receiving payments at age 70 ½. The intent of these minimum distribution rules is to make sure that retirement accounts provide retirement income to the owner rather than acting as a tax deferred vehicle to transfer such account to the owner's beneficiaries.
Why Congress Provided Relief
Investments in the retirement plan or IRA are usually sold to provide the cash to make the distribution. Because of the 2008 reduction in stock values and other investments, Congress has provided relief from the need to sell assets at a substantial loss in order to make the minimum distribution. This temporary relief is a complete waiver of the need to make the 2009 minimum required distribution.
Relief Provided to Plan Participants and Beneficiaries
Participants and beneficiaries receiving minimum distributions can choose to forgo such payments in 2009, and instead leave the funds in the retirement plan. This defers tax on such distributions into the future.
The same relief is provided to beneficiaries of the original owner of the account who are receiving either the five-year payout or a lifetime payout following the death of the original owner of the retirement account.
This new relief applies to IRAs and individual account plans such as 401(k), profit sharing, 403(b) and certain 457(b) plans. It does not affect annuity-type payments from a retirement plan (e.g., a defined benefit plan or insurance annuity), which will continue to be made as before.
Roth IRAs and Roth 401(k) accounts are not taxed on a distribution and are not subject to the minimum distribution rules for the owner of the account. However, beneficiaries of the account are subject to the minimum distribution rules and are entitled to the 2009 relief.
The relief is only for minimum distributions for 2009. Minimum distributions for 2008 should have already been made, except for those recipients in their first year of payment (i.e., turned 70 ½ in 2008). For those whose first minimum distribution was due for 2008, there is a three-month grace period to April 1, 2009, to receive the first payment. Even though the first payment is due in 2009, the distribution must still be made because it is for the year 2008. The second minimum distribution that would be paid by Dec. 31, 2009, can be waived.
Plan Amendments May Be Required
It is not clear whether a retirement plan must be amended to provide retirees with the option not to receive payment in 2009. Since all plans are required to have terms that comply with the minimum distribution rules, avoiding such payment could be a violation of the plan terms. At a recent conference the IRS stated it is working on this and other issues related to implementation of the waiver of the rules for 2009.
Tax Withholding and Other Information
IRA custodians and retirement plan administrators are not required to provide the calculation of the minimum distribution for 2009. But most custodians we are aware of will continue to provide the statement, and retirement plan sponsors may want to continue to provide that information to retirees since it could impact any tax withholding. IRA custodians are taking different approaches on whether to suspend the 2009 distribution unless the account owner opts to receive it, or to require the owner to opt out of payment.
If a retiree wants to receive a distribution for 2009, the retiree may select the payment amount. Payment up to the amount of the minimum required distribution will not be subject to the mandatory withholding rules, but any amount in excess of such amount will be subject to the mandatory 20 percent federal income tax withholding. As a result, the plan administrator should be sure to have a valid withholding election form in place for the amount up to the minimum distribution amount, and to withhold at the 20 percent rate for amounts in excess of the minimum distribution amount.
Because such payments are not required in 2009, the retiree can roll over a distribution in 2009 to an IRA or other retirement plan that accepts rollovers. However, a plan administrator does not have to provide the direct rollover notice that applies to discretionary payments.
Legislation has been introduced that would extend the relief from the minimum distribution rules to 2010 and even back to 2008 when much of the reduction in stock values took place, but it is unclear whether such extended relief will be enacted into law.
Actions to Take
I. For retirees subject to minimum required distribution:
- Decide whether to avoid the minimum distribution for 2009. Factors include the availability of other funds for living expenses, the impact on investments, and the overall estate and retirement plan.
- Communicate decisions to either receive or not receive the distribution for 2009 to the IRA custodian or retirement plan administrator.
- If taking a distribution, decide on the amount of tax withholding and notify the IRA custodian or retirement plan administrator.
II. For employers administering retirement plans:
(If an outside plan administrator is used, employers must communicate with the administrator regarding these steps).
- Determine if any retirees or employees are impacted by this relief.
- Decide if the waiver of the minimum distribution will be an option for employees, or whether simply to continue with the distribution schedules. Most employers will want to provide the option to employees and retirees since it is a no-cost benefit.
- Review the retirement plan and determine if a plan amendment is necessary. While the official plan amendment can be delayed per IRS rules until 2011, employees and retirees will need notice of any change in a timely manner to make their choice.
- Send notice to retirees and impacted employees with the decision. If the choice is to allow the option of waiving the minimum distribution, the employer should decide whether the default position (i.e., if the retiree does not respond) is to make the minimum distribution or not. Since retirees have already elected a payment stream, employers will likely want to make the default election a continuation of the minimum distribution.
- Send tax withholding election forms for those retirees who elect to receive the minimum distribution.
- Ensure any distribution in excess of the minimum distribution amount has the mandatory federal 20 percent withheld.
Retirees: Please contact your DWT Trust & Estates attorney.
Employers: Please contact your DWT Employee Benefits attorney.