Required minimum distributions (RMDs) are not frequently discussed during retirement planning. But when they are, they can be quite burdensome to administer. The rules surrounding RMDs can be complex, with numerous exceptions, and recent changes in the law have only added to this complexity.
Wouldn’t it be nice if retirement plan administrators didn’t have to worry about RMDs? They often don’t.
Retirement plans can avoid the chaos of required minimum distributions (RMDs) by utilizing the plan’s force-out provisions and setting up automatic rollover IRAs for participants who have terminated employment and reached normal retirement age (NRA). Before we delve into how to bypass RMDs, we’ll first provide some context by explaining why RMDs have become more burdensome recently. Understanding these new complexities may lead to serious consideration of implementing force-outs at NRA.
Increased RMD Headaches
Retirement plans were not designed to be used for estate planning. Their main purpose is to provide individuals with enough funds to be financially secure after they stop working. The Required Minimum Distribution (RMD) process, which has been around since the passage of ERISA, ensures that participants use their retirement benefits or are taxed on them. However, what was once a simple concept has now become an operational nightmare.
RMD Start Date
There used to be just one age for beginning RMDs—70 ½. With the recent passage of the SECURE Act and SECURE Act 2.0, RMDs can now begin at one of four different ages that depend on the participant’s birth year.
| Birth Year | RMD Age |
|---|---|
| Born before 7/1/1949 | 70 1/2 |
| Born after 6/30/1949 and before 1/1/1951 | 72 |
| Born in 1951 through 1959 | 73 |
| Born after 1959 | 75 |
There is an exception to starting RMDs at this time if the participant is still working at the applicable age. However, it’s important to note that there is an exception to this exception for more than 5% owners of the business. These individuals, due to their significant ownership, cannot wait until termination of employment. They must commence RMDs at the RMD age regardless of employment status.
RMD Distributions Upon Death
Before the SECURE Act (the first one, not 2.0), beneficiaries usually were able to stretch out the RMD payments over their lifetime. For participants who pass away after 2019, only “eligible” beneficiaries may receive the lifetime RMD distributions upon the death of the participant. An “eligible” beneficiary would be defined as the participant’s:
- Spouse
- Children under the age of 21
- Beneficiary who is no more than ten years younger than the participant
- Beneficiary who is disabled or chronically ill
Suppose the plan allows for lifetime RMD payments upon death. In that case, the administrator must verify that the beneficiary meets this “eligible” criteria, including specifically whether the beneficiary is disabled or even chronically ill.
Payment Term for Eligible Beneficiaries that are not eligible
Beneficiaries not meeting the “eligible” definition above must be paid the entire account balance within ten years. While this seems straightforward, there are a few exceptions:
- If RMDs have already begun to the participant before death, a portion of the balance “may” need to be paid annually, although the entire balance is not required to be paid until the end of the ten years. The word “may” is in quotes because the IRS has yet to confirm its interpretation of this requirement. See IRS Notice 2023-54.
- When a children reach age 21, they may no longer receive lifetime RMD payments. The 10-year period starts at age 21, and the remaining balance must be paid out before the end of that period.
- Suppose a trust or the participant’s estate is listed as the retirement beneficiary. In that case, the entire account must be paid out prior to the end of five years instead of 10 (another exception to an exception).
Any failure to comply with the above payment terms or any RMD requirement for that matter can result in the participant or beneficiary being liable for an excise tax of up to 25% of the relevant amount.
Force-Out Distributions at NRA
If you find the RMD process overwhelming, you can avoid it. Retirement plans may require terminated employees to withdraw their account balance by the plan’s defined normal retirement age (NRA).
Force-Outs Aren’t Just For Small Balances
Force-out provisions apply to terminated participants with a balance of less than $7,000. This process can also be used for terminated participants who reach normal retirement age. Participant consent is only required for distributions before the participant attains the plan’s normal retirement age (or age 62, if later).
To illustrate, Joe left his employer at age 56. He received the distribution notice and election forms but kept his money in the employer’s plan. When Joe reaches the retirement plan’s NRA of 65, he would again receive a distribution notice and election form. But now it states that failure to make an election can result in a force-out distribution. If Joe does not complete the second election form promptly, a force-out distribution occurs.
Although the force-out distribution will not be required to be sent to an automatic rollover IRA, using an auto rollover IRA can benefit both the plan sponsor and the administrator.
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Getting Started with Force-Outs at NRA
If you and the company are on board with force-outs at NRA to avoid the headache and cost of the entire RMD process, the next question is: “What happens next?” The answer is typically a plan amendment.
Even though the IRS only requires participant consent up to NRA, many pre-approved plan documents will default to always requiring participant consent before processing any distributions for balances above $7,000 – at least up to when RMDs begin.
As a result, a plan amendment could be required to change the ability to force out any terminated participants at the retirement plan’s NRA. In addition, the amendment could be applicable for all plan participants, both former and current employees, along with their existing account balances. Said differently, there does not appear to be a protected benefit issue. The IRS appears to exempt the use of any force-out distributions at NRA from the anti-cutback rule. See Treas. Reg. 1.411(d)-4 and Q&A 2(b)(v).
Potential Cons to NRA Force-Outs
While force-outs at NRA alleviate the RMD complexity, there are several other factors to consider.
First, these provisions must be applied consistently to all participants, like force-outs of small balances. The business owner’s balance can’t be left in the plan after NRA, while all participants are forced out at NRA. Second, some participants, especially business owners, may use the retirement plan as an extra layer of protection from bankruptcy or judgment creditors.
Some plan sponsors may believe it is unfair to force out terminated participants at NRA. However, whether through affirmative election or an auto rollover IRA, individuals may have certain advantages in having their assets in an IRA. For example, the expanded choice of investments may better suit their circumstances, including potential retirement income options. Using an IRA may also provide additional flexibility in how RMDs are eventually processed.
These factors should be considered in determining the best course of action.
Is a Cash Balance or Defined Benefit Plan Right For You?
Prevent RMDs From Being an Administrative Headache
Using force-out distributions and automatic rollover IRAs for terminated participants at NRA allows you and your plan sponsors to avoid RMD complexity.
RMDs have become more burdensome lately, especially with different RMD ages, revised payment terms, and the definition of “eligible” beneficiaries. Given the burden and potential for error, it may be time to prevent this unnecessary time and expense by using force-outs at NRA. You may only need a plan amendment.
