IRS Issues Guidance on Repeal of Minimum Distribution Rule

From Employee Benefits Alert

October 1997

One of the changes enacted by the Small Business Jobs Protection Act of 1996 ("SBJPA") was the elimination of the requirement that minimum distributions commence at age 70 1/2 for employees who continued working after age 70 1/2. Under the new law, minimum distributions must commence for all participants (other than 5% owners) on April 1 following the later of attainment of 70 1/2 or termination of employment. The new minimum distribution rule is effective January 1, 1997. The prior rule will continue in effect for 5% owners.

While on its face the new rule would seem easy to implement, it is actually quite difficult because of the anti-cutback rules. All plans contain the minimum distribution rule requiring that minimum distributions commence when the participant attains age 70 1/2 even if the participant is still employed. The IRS views compliance with the minimum distribution rule as providing a right to employees to receive in service distributions once they reach age 70 1/2. This right is considered an optional form of benefit and therefore subject to the anti-cutback rules. Accordingly, employers will not be able to simply amend their plans to conform to the new law, because the elimination of the right to receive the in service distribution would be a cutback in an optional form of benefit.

In order to assist employers in determining how and when their plan should be amended, the IRS has issued certain guidance in the forms of notices, announcements and proposed regulations. The important guidance issued to date is discussed below.

Transition Relief

Although the change in the minimum distribution rule was effective January 1, 1997, the IRS has ruled that the new law also applies to participants who attained age 70 1/2 in 1996 but did not retire in that year. Even though the provisions of a plan require that distributions to such employees commence on or before April 1, 1997, a number of employers did not make distributions due to confusion regarding the effect of the new law. The IRS has provided transition relief for employers who have not amended their plans to remove the minimum distribution provisions and want to permit employees who reached age 70 1/2 in 1996 but did not retire to elect to defer their distribution until after retirement. The transition relief applies only if: (i) the employer offers the deferral option to employees and the employees either elect to defer receipt of their distributions or to receive a make-up distribution, and (ii) the employee deferral option or the make-up distribution meets the requirements of Section 401(a) of the Code (other than the requirement that the plan operate in accordance with terms). The IRS has indicated that any employer who permits employees to defer distributions in this manner would be required to amend the plan retroactively, pursuant to future IRS guidance, to include the deferral option.

It should be noted that employers are not required to give employees the right to defer the distribution of benefits. Employers can continue to adhere to the provisions of the plan currently in effect. However, if an employer wishes to allow those who attained age 70 1/2 in 1996 and did not retire to defer distributions, it must meet the IRS requirements for transitional relief. If an employer determines to offer the deferral election, the employee must make the election no later than December 31, 1997. If the employee does not make a deferral election, then the employer must pay a make-up distribution.

Make-up distributions must be made to any employees who do not elect to defer their distributions or if the employer does not make the deferral election available to employees, then to all employees who attained age 70 1/2 in 1996, did not retire and did not begin receiving minimum distributions by April 1, 1997. The make-up distribution must place the employee in the same position as if the employee received minimum distributions in accordance with the terms of the plan. Make-up distributions must be completed by December 31, 1997.

Deferral Election

The IRS has also made it clear that an employer may offer to employees (other than 5% owners) who attained age 70 1/2 after 1995 and have not retired, an option to defer commencement of distributions under a qualified plan prior to the date of the plan has been amended to provide for such option. For employees who reach age 70 1/2 after 1996, the deferral election should be made before April 1 of the year following the year in which they attain age 70 1/2 (i.e., before April 1, 1998 for employees who reach 70 1/2 in 1997). This provision will remain effective until the plan has been amended to comply with SBJPA.

The IRS guidance issued to date does not address the conditions under which employers may offer employees who had already been receiving minimum distributions (i.e., employees who reached age 70 1/2 in 1995 or earlier) an election to stop receiving distributions until a date no later than April 1 of the year following their retirement. The IRS has warned employers that offering such an election could violate qualification requirements. Future IRS guidance will discuss when such an election can be made available.

Proposed Regulations

The IRS has issued proposed regulations specifying what plan amendments can be adopted to change minimum distribution rules without violating the anti-cutback rules. The proposed regulations would permit employers to stop making pre-retirement distributions to employees who reach age 70 1/2 after December 1998. Under the proposed regulations, employers may amend their plans to eliminate the required pre-retirement distribution with respect to employees who reach age 70 1/2 in 1999 or a later calendar year specified in the amendment. For employees who reach age 70 1/2 during 1997 or 1998, the employer cannot preclude employees from receiving a preretirement distribution as an optional form of benefit after reaching age 70 1/2. Eliminating the right to receive such a distribution would be a reduction of benefits. Employers also cannot preclude an employee who retires after the calendar year in which the employee reaches age 70 1/2 from receiving an optional form of benefit that would have been available if the employee had retired in the calendar year in which the employee had attained age 70 1/2.

The effect of the proposed regulations is to allow the implementation of the new distribution rules for those who attain age 70 1/2 on or after January 1, 1999. Anyone who attains age 70 1/2 prior to that date must either receive the required distribution specified in the plan, or be given an election to defer the commencement of their benefit as specified above.

The proposed regulations indicate that the deadline for adopting amendments would be the last day of any remedial amendment period that applies to the plan for changes adopted in the SBJPA. The deadline would be December 31, 1998, at the earliest. The IRS has not yet issued any general guidance regarding plan amendments implementing the SBJPA provisions and is not accepting determination requests with respect to such amendments.