RMD Issues: Calculating a Term Certain Annuity; Absence of a Benefit Election
Oh, the pesky RMD! Rather than delving into the basic rules, I’d like to discuss some controversial issues that have recently been brought to my attention.
Calculating a Term Certain Annuity
Recently, there was a long discussion on the ACOPA listserv about how to calculate the RMD for a traditional defined benefit plan. The normal form of payment is a single life annuity, and the elected form of payment is a 25-year term certain annuity.
§1.417(e)-1(d)(1) specifies a minimum benefit amount for distribution forms that are subject to Internal Revenue Code §417(e)(3). In particular, it states:
A defined benefit plan must provide that the present value of any accrued benefit and the amount ... of any distribution, including a single sum, must not be less than the amount calculated using the applicable interest rate ... and the applicable mortality table ... The present value of any optional form of benefit cannot be less than the present value of the normal retirement benefit determined in accordance with the preceding sentence.
Since installment forms of payment without life contingencies (such as a 25-year term certain annuity) are subject to §417(e)(3), the minimum amount must be calculated using §417(e) assumptions.
It’s best to illustrate the issue using an example: A participant is age 71 and has a single life annuity benefit of $10,000 per month.
- The plan’s definition of actuarial equivalence is 5% interest and the 1994 Group Annuity Reserving mortality table. Using plan assumptions, the annual 25-year term certain annuity is $10,000 * 119.23137 / 14.79864 = $80,569.
- The §417(e) assumptions are segment rates of 1.82%, 4.12%, and 5.01% and the 2016 Applicable Mortality Table for §417(e). Using 417(e) assumptions, the annual 25-year term certain annuity is $10,000 * 132.96675 / 15.91559 = $83,545.
- The participant should receive the larger of the two, or $83,545.
There is another camp that believes only the lump sum value of the single life annuity is subject to §417(e). In the example above, the lump sum payable is determined using §417(e) assumptions, $10,000 * 132.96675 = $1,329,668. The 25-year term certain annuity is then determined using plan assumptions, $1,329,668 / 14.79864 = $89,951. I do not believe this "mix-and-match" methodology is correct.
Absence of a Benefit Election
When entering pay status as a result of an RMD, a participant may elect any of the optional forms available under the plan. In absence of an election, the plan should automatically pay the Qualified Joint and Survivor Annuity (QJSA) defined in the plan.
There is some controversy regarding the death benefit when an active participant commences RMDs without an election and subsequently dies prior to actual retirement. Consider the following:
- RMD payments must comply with the Minimum Distribution Incidental Benefit (MDIB) requirements under §401(a)(9)(G). “Incidental benefits” are those benefits which are not really retirement benefits but are benefits that are ancillary to the plan. The primary purpose of the MDIB requirements is to ensure that the participant, not the beneficiary, is expected to receive most of the retirement benefit. Forms that generally meet the MDIB rules include a single life annuity, a joint and survivor annuity, a term certain annuity or certain and life annuity (subject to limits on the length of the term), and a lump sum settlement. A life annuity with the death benefit equal to the present value of the remaining payments does not satisfy the MDIB requirements.
- §1.401(a)(9)-6, A-13(b) allows participants and beneficiaries to change the form of future payments in certain circumstances, including actual retirement. §1.401(a)(9)-6, A-14(a)(5) permits annuity payments to increase “to allow a beneficiary to convert the survivor portion of a joint and survivor annuity in to a lump sum upon the employee's death.” It does not permit the conversion of a beneficiary’s annuity other than upon the employee’s death. The resulting lump sum is the present value of the single life annuity payable to the surviving spouse for the remainder of his or her lifetime. Note that Notice 2015-49 indicates that the Treasury and IRS intend to amend the final regulations so that plans may not allow an annuity form of payment to be converted into a lump sum payment or other accelerated form of distribution.
Without an election, an unmarried participant will begin payments in the form of a single life annuity, and a married participant will begin payments in the form of a joint and survivor annuity defined in the plan. The fact that the benefit commenced by default rather than by an active election does not change the treatment of the participant's status. He or she should be treated as retired with an irrevocable form of payment until the participant and/or plan meets one of the criteria under §1.401(a)(9)-6, A-13(b). Therefore, the pre-retirement death benefit is not preserved; the death benefit is simply determined by the form of payment.
There is another school of thought that views “pre-retirement” as pre-termination of employment. Their thinking is that an active participant in payment status should be entitled to a pre-retirement death benefit, regardless of the form of payment. I do not see any statutory basis for this rationale.
Regardless of your position, pay attention to the plan document and consider the ramifications of retroactive problems when future regulations are released.