By now we all know the tax benefits of defined benefit plans and cash balance plans. But are they subject to required minimum distributions (RMDs)? We will take a close look.Quick Links
- How do RMDs Work?
- RMDs for Defined Benefit Plans
- RMDs for Cash Balance Plans
- Are RMDs Required for Defined Benefit Plans and Cash Balance Plans?
How do RMDs Work?
Special deferred tax treatment is given to retirement plan assets in order to encourage employers to provide retirement plans and participants to save for retirement. However, the government has put rules into place under IRC §401(a)(9) in order to collect on the deferred tax revenue if the participant hasn’t taken a distribution by age 72.
In addition, these rules restrict the amount of retirement plan assets that are passed on to heirs. These are called required minimum distributions or RMDs. IRC §401(a)(9) requires that minimum distributions be made and imposes a 50% excise tax (to be paid by the plan participant) for RMDs that are not made.
RMDs for Defined Benefit Plans
Thanks to the SECURE Act, RMDs generally start in the year a participant turns 72. They must be started by April 1st of the year after the year in which you turn 72. There are different rules that apply for 5% owners and those that are not. For participants who are 5% owners, the RMDs must start for the year in which they turn 72.
For non-five-percent owners, RMDs must start the later of the year in which they turn 72 or the year in which they terminated service. A year for which an RMD is required is called a distribution calendar year. Once minimum distributions begin for a participant they will continue as long as they have a benefit under the plan. Except for the first distribution year, RMDs must be made by the end of their distribution year.
For a 5% owner, the first required minimum distribution year is the year the 5% owner attains age 72, and is not delayed until actual retirement as it is for non-5% owners. Any lump-sum distribution made during a distribution calendar year will only be eligible for rollover to the extent it exceeds the RMD for the year.
Defined benefit plans and cash balance plans (a type of defined benefit plan) are subject to these rules just like IRAs and other qualified plans are. But there is one significant consideration. Only the vested amounts are subject to RMDs, while non-vested balances are not. With most plans having 3-year cliff vesting, that can offer a slightly longer time frame to be subject to the RMD.
Defined benefit plans must use the annuity method to determine the RMD. If the entire accrued benefit is being distributed as a lump sum, the account balance method can be used. Defined contribution plans generally use the account balance method to determine the RMD. If the QJSA benefit is not waived, a defined contribution plan must use the annuity method.
Under the account balance method, the RMD is the level payment amount of the current account balance over the life expectancy of the participant or the joint life expectancy of the participant and beneficiary. However, if a joint life expectancy is used, a non-spouse beneficiary must be treated as no more than ten years younger than the participant. This is part of the minimum incidental distribution benefit (MIDB) requirements.
Under the annuity method, the RMD is generally that amount that would be paid as a level annuity to the participant or jointly to the participant and a beneficiary. As with the account balance method, a non-spouse beneficiary must be treated as no more than ten years younger than the participant to satisfy the MIDB requirements.
RMDs for Cash Balance Plans
For the first distribution calendar year, the RMD must be made no later than April 1st of the next calendar year. If the annuity method is being used, subsequent RMD payments must be made no less frequently than annually. For instance, if the annuity method is being used, the first payment is on April 1st, and the payments are annual, the next payment must be made by the following April 1st.
Under the account balance method, however, the RMD for each successive distribution calendar year must be made by December 31st of that year. In most cases, this means the participant will receive two RMDs in the year following age 72 if using the account balance method, one for their first distribution calendar year and one for their second distribution calendar year.
Are RMDs Required for Defined Benefit Plans and Cash Balance Plans?
So now you have the answer. RMDs are required but they are subject to vesting and other special considerations. But remember – in most cases for small business owners they will be rolled over into IRAs before RMDs are required.