It won’t be long and April 1st will soon be upon us. One requirement for ESOPs and other qualified retirements plans is to distribute Required Minimum Distributions (RMDs) to eligible plan participants.
The IRS requires payments to participants by their “required beginning date” (RBD) under IRC Section 401(a)(9). A minimum payment must be made to the participant as of the RBD, and for each calendar year thereafter. The participant is not able to delay distribution beyond the required beginning date (RBD).
For a participant who is not a 5% owner, the RBD is defined as April 1 following the end of the calendar year in which the later of two events occurs: (1) the participant reaches age 70½, or (2) the participant retires. For a participant who is a 5% owner, the RBD is April 1 following the close of the calendar year in which they attain age 70½, regardless of whether they retire by the end of that year.
Your TPA should be advising your RMDs due in April, along with the distribution amount based on the life expectancy tables used in your ESOP plan document. For an ESOP, a RMD is calculated for each account by dividing the prior December 31 balance of the ESOP account by a life expectancy factor that IRS publishes in Tables in Publication 590, Individual Retirement Arrangements (IRAs). Your ESOP document will reference some or all of these tables:
- Joint and Last Survivor Table - use if the sole beneficiary of the account is a spouse and the spouse is more than 10 years younger than the participant;
- Uniform Lifetime Table - use if the spouse is not the sole beneficiary or the spouse is not more than 10 years younger than the participant; and
- Single Life Expectancy Table – use for the beneficiary of an account.
In the case of an employee that is a participant on two or more employer retirement plans, a 401(k) plan and an ESOP for example, RMDs are required to be taken separately from each plan. However, even though an IRA owner must calculate the RMD separately for each IRA that they own, they can withdraw the total RMD amount from one or more of the IRAs.
There is a stiff 50% penalty of the RMD amount imposed on the participant for failure to take the RMD, so this is one plan requirement you really need to monitor! If an individual fails to receive their RMD, they should file Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, with their federal tax return for the year in which the full amount of the RMD was not taken.
The IRS can waive part or all of this tax if the individual can show that any shortfall in the amount of distributions was due to reasonable error and they are taking reasonable steps to remedy the shortfall. To request a waiver, a letter of explanation should be attached with the filed Form 5329. The IRS will review the information provided and decide whether to grant the request for a waiver.
The tax-qualified status of an ESOP can be lost if a plan sponsor fails to distribute the entire RMD in any year. The plan sponsor can correct an RMD failure using the Voluntary Correction Program (VCP) submission through the IRS EPCRS program, or by using the Self-Correction Program (SCP) if the correction is made within two years after the plan year in which the violation occurs.