Posted by Maria T Hurd, CPA
Updated November 11, 2020
The CARES Act gave us a Required Minimum Distribution (RMD) holiday during 2020, but the SECURE Act’s new RMD rules will be back in 2021. How will the changing rules affect financial statement audits?
RMDs under the SECURE ACT
The SECURE Act (Setting Every Community Up for Retirement Enhancement Act) changed the Required Minimum Distributions (RMDs) age prospectively. Terminated participants who are not 5% owners of their employers and should reach age 70 ½ after 2019 must take their first RMD by the April 1 of the later of (i) the year after they reach age 72 or (ii) the year after they retire. Five percent (5%) owners must begin their RMDs by April 1 of the year following the year they turn 72, even if they do not retire.
The RMD rules apply to all employer-sponsored retirement plans and IRAs, including Roth 401(k) accounts, but not Roth IRAs while the owner is alive. Distribution of RMDs is a per plan requirement so participants do not have the option of taking their RMD amounts attributable to balances in multiple retirement plans from only one of the plans. However, 403(b) contract owners can calculate the RMD separately for each 403(b) contract they own, and then take the full RMD from only one or some of the 403(b) contracts.
Failure to Make RMDs: Whose Fault is It?
Failure to make an RMD is considered an operational error that could negatively affect the qualified status of the plan and all of the participants. For this reason, failures to make RMDs must be corrected even if the missed distribution is immaterial to the financial statements.
Plan sponsors cannot assume that their responsibility is limited to ensuring that the recordkeeper is sending RMD notices. The notices often do not reach the participants, and sometimes, recordkeepers only distribute the amount that the participant requests, which may be insufficient to satisfy the required minimum.
The Correction Options
The Employee Plan Compliance Resolution System (EPCRS) offers various correction options to plan sponsors who fail to make Required Minimum Distributions (RMD).
Self-Correction Program (SCP)
Plan sponsors can self-correct minor operational errors under SCP at any time, which is convenient and cost-effective, but in the case of missed RMDs, there is a downside that may affect the participants. Under SCP, the participant-owed excise tax under Internal Revenue Code (IRC) 4974 is not automatically waived.
An onerous excise tax of 50 percent is imposed on the amount of the RMD not received by the participant and is paid with the participant’s individual federal tax return for the year the RMD was not taken, through Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax Favored Accounts. In certain situations, the IRS may waive the penalty if the taxpayer attaches a letter explaining that the RMD failure or shortfall was due to reasonable cause and that steps are being taken to catch up the payments.
Voluntary Correction Program (VCP)
If the administrator determines that the failure to make RMDs was not a minor error, the failure can be corrected through the IRS VCP. Under VCP, the plan sponsor would pay a fee to submit a suggested correction method to the IRS for approval, including a request to forgive the affected participant’s excise tax. The submission is made on Form 14568-H, Schedule 8: Failure to Pay Required Minimum Distributions Timely.
An RMD Holiday: The CARES Act Waives RMDs for 2020
In March of 2020, the Coronavirus Aid, Relief, and Economic Security (CARES) Act waived the RMD requirement for defined contribution retirement plans for any distribution attributable to the year 2020 and any first time RMD attributable to 2019 that would have been paid by April 1, 2020.
RMDs that had already been taken could be rolled over through August 31, 2020. Any other distributions taken during 2020 are treated as eligible rollover distributions, even if they represent what would have been an RMD. Lastly, if the participant is a Coronavirus Affected Individual (CAI), as defined by the Act, then the distribution is a Coronavirus Related Distribution (CRD), and the participant has three years to roll over the distribution to the distributing plan, if permitted, to another retirement plan, or to an IRA. Additional CRD administration specifics are beyond the scope of this blog.
Potential Audit Procedures for RMDs
As was the case when auditing RMDs under the old rules, some typical audit procedures financial statement auditors perform include:
- For 2021 audits, sorting the census to isolate terminated participants 72 years or older and 5% owners over 72, as well as identifying participants with continuing RMD requirements.
- Verifying relevant participant data, such as age and employment status.
- Selecting the sample of required minimum distribution eligible participants who will be tested.
- Recomputing minimum distribution amount based on the participant account balance.
- Verifying proper coding on Form 1099-R.
- Requesting cancelled check. Alternatively, auditors sometimes confirm receipt of distributions and participant data with the participants.
- If applicable, reviewing recordkeeper’s SOC 1 report for exceptions in the minimum distribution processes.
- Verifying missing participant location processes are in place, if applicable.
The shift in the RMD age from 70 ½ to 72 will not change the audit procedures performed, but the RMD holiday gives us an opportunity to revisit a plan sponsor’s administrative responsibilities and see whether the processes in place for 2021 RMDs are designed to prevent operational failures. In many cases, changes in the law lead to mistakes when systems and processes are not updated timely. In those cases, correction programs are available to make things right.