IRS Issues Guidance on Minimum Distributions

From Employee Benefits Alert

February 1998

Our October 1997 Employee Benefits Alert discussed the repeal of the minimum distribution rule, which required that employees begin to receive qualified plan distributions no later than April 1 of the year after they attain age 70½. Beginning January 1, 1997, the minimum distribution rule applied only to 5% owners. Employees other than 5% owners are not required to begin receiving distributions until April 1 of the year after the later of (i) the year they retire, or (ii) the year they reach age 70½.

Although the IRS had previously issued guidance for employers in applying the new rule, there were some questions that were not answered by this earlier guidance. In December, the IRS finally issued Notice 97-75, which provides answers to these open issues in question and answer format.

Employees Who Reached Age 70½ Before 1997

Employees who had reached age 70½ before 1997, did not retire, and began receiving minimum distributions may be permitted (but not required) to make an affirmative election to stop distributions at any time until the employee retires, subject to the terms of any applicable qualified domestic relations order. Although the election to stop and restart benefits generally is subject to the spousal consent rules of IRC sections 401(a)(11) and 417, the IRS Notice provides two safe harbor election procedures that will not violate sections 401(a)(11) and 417.

Under the first procedure, the plan may provide that there is no new annuity starting date when the distribution of benefits recommences. No spousal consent will be required to stop the benefits. In addition, spousal consent will not be required to restart the benefits if (i) there is no change in the beneficiary or the form of distribution, (ii) the employee's spouse executed a general consent when the benefit distributions first began, or (iii) the employee's spouse at the time benefit distributions first began executed a specific consent to waive the qualified joint and survivor annuity and is no longer the employee's spouse when benefits recommence.

Under the second safe harbor, the plan may provide that there is a new annuity starting date when the distributions recommence. Spousal consent will then be required to elect to stop distributions only when the distributions are in the form of a qualified joint and survivor annuity. Such consent must acknowledge the effect of the election. When benefits recommence, the new annuity starting date requires that the notification and consent rules of section 417 be satisfied.

In either case, the plan must be amended before the end of the remedial amendment period and the distributions must cease before the end of the remedial amendment period.

Eligibility for Rollovers

Benefit distributions that commence before the employee retires may be "eligible rollover distributions" that may be rolled over to an IRA or qualified plan, and are subject to 20% withholding if they are not transferred directly to an IRA or qualified plan. Distributions that are required under the minimum distribution rule are not eligible rollover distributions. Distributions in the form of an annuity on one or more lives or for a period of at least 10 years are also not eligible rollover distributions. Whether or not an employer decides to permit employees to take preretirement distributions after reaching age 70½ or to elect to stop distributions that had commenced under the old minimum distribution rule, the employer must consider the effect of the rollover, withholding and notice rules on distributions that are made before retirement. Because the preretirement distributions will no longer be required minimum distributions, they may be "eligible rollover distributions" subject to possible 20% withholding.

Maintaining Old Minimum Distribution Rule

A plan may continue to require that minimum distributions be made in accordance with the old rule (i.e., to all employees regardless of whether they are 5% owners). If the plan maintains the old rule, then April 1 of the year after the employee reaches age 70½ will be treated as the required beginning date for purposes of section 401(a)(9). For example, if an employee dies after the required beginning date determined under the plan, he will be treated as dying after the required beginning date for purposes of section 401(a)(9)(B), and the employee's benefit must be distributed at least as rapidly as under the method being used at the time of the employees death. As noted above, however, retaining the old rule will not cause the preretirement distributions to be required distributions under section 401(a)(9).

Coordination of Nondiscrimination and Minimum Distribution Rules

When applying the nondiscrimination rules, minimum distributions made to 5% owners generally will not cause the plan to be discriminatory merely because such distributions are not available to employees who are not 5% owners.

Actuarial Increase for Defined Benefit Plans

When an employee continues working after reaching age 70½ and then retires in a later plan year, his benefit must be actuarially increased in order to take into account the period after age 70½ during which he is not receiving benefits from the plan. The actuarial increase must reflect the delay from April 1 of the year following the year in which he attained age 70½. In the case of an employee who reached age 70½ before 1996, the starting date for the period of the actuarial increase is January 1, 1997. The actuarial increase must be calculated through the date on which the employee begins receiving benefits under the plan in an amount sufficient to satisfy the minimum distribution rule.

IRS Issues Year End Guidance on Many Employee Benefits Questions

In addition to the IRS Notice discussed above, the IRS also issued numerous other year-end notices regulations and proposed regulations providing guidance to many employee benefits questions. Guidance was issued regarding cafeteria plan elections, qualified plan loans, COBRA continuation coverage, and taxation of qualified plan annuity payments. We will discuss these topics in future issues of the Employee Benefits Alert.

For further information regarding the modification of the minimum distribution rule or for information on other employee benefits matters please contact Paul J. Powers, Jr. or Kirk H. O'Ferrall at our New York office.