The Distribution Pickle
It’s a summertime trap: the poor baseball player trapped between bases who is going to be tagged out no matter which direction he goes. A recent blog entry argues that such a pickle faces employers and plan administrators too concerning distributions, but at any time of the year.
Any employer and plan administrator can readily attest that complying with and applying tax laws and regulations in running a retirement plan can be complex and challenging. Not only that, meeting employee desires and requests while at the same time remaining in compliance can replicate the experience of being trapped between second and third with nowhere to go.
In “Catch 22 Situations with Retirement Plans
,” Morningstar’s Natalie Choate points out that there can be situations that arise concerning distributions that are complicated by laws and regulations that appear to conflict, or actually do. “Sometimes you need a particular form of distribution to achieve a certain tax result, but the retirement plan doesn't allow it. Or sometimes the tax law seems to say opposite things about the same distribution,” she writes.
Choate offers a scenario relevant to 403(b) plans that illustrates the challenges distributions can entail.
Suppose a participant needs to take catch-up RMDs but the plan won't allow it. An employee who is over age 70½ participates in a 403(b) annuity plan through the university where he works; he also has an IRA.
For more than four years he computed his required minimum distributions (RMDs) for the annuity plan and the IRA, but took the combined amount only from his IRA. This was a mistake, writes Choate: 403(b) RMDs can only be taken from 403(b)s, and IRA distributions cannot be used to satisfy the RMD requirement for other kinds of plans. The IRS, she says:
- considers the participant to have missed four years’ worth of RMDs from his 403(b);
- owes 50% excise tax on the missed RMDs; and
- took many extra taxable distributions from his IRA.
To fix this, Choate says, the participant needs to ask the IRS for penalty waivers for the RMDs it says he missed. Since the participant must remedy the shortfall — that is, take catch-up distributions — the participant asks the 403(b) plan for a lump sum equal to those four years’ worth of missed RMDs. The plan does not allow lump sum payments, however; the only options the plan offers are that year’s RMD and/or a 10-year installment payout. In this case, Choate says, the participant “is good and stuck unless he gets either the IRS or the 403(b) to bend a little.” She adds, “Hopefully the 403(b) plan will realize that distributing this year’s RMD should include the ability to take prior years’ missed RMDs.”