The changes in the required minimum distribution (“RMD”) rules for 2009 that are part of the Worker, Retiree, and Employer Recovery Act of 2008 (“WRERA”) continue to receive substantial discussion. In a Technical Update earlier this week (referred to herein as “RMD Tech-1”), SunGard discussed the WRERA RMD law changes and potential administrative approaches for 2009 RMD recipients. This Technical Update addresses some issues of continuing interest regarding the interpretation of the new law, as well as informal discussion with IRS National Office personnel.

The law. Under WRERA, the 2009 RMD requirement for defined contribution plans (e.g., 401(k) and profit sharing plans) and for individual retirement accounts (“IRAs”) is waived. In addition, WRERA amended the rollover rules to provide that if part or all of a distribution would be treated as an eligible rollover distribution (“ERD”), but for the fact that the distribution would be an RMD (which is a category of distribution not eligible for rollover), the plan (or IRA) need not treat the distribution as an eligible rollover distribution for purposes of the notice, withholding and direct rollover requirements that normally would apply to an ERD.

The problem. The statutory change seems to pave the way for (and apparently was intended by Congress to permit) the rollover of a 2009 RMD, thereby enabling the recipient to defer a taxable distribution in favor of letting the RMD amount continue to grow (and hopefully recover market losses) on a tax-deferred basis. The problem, as explained in Q&A-4, Example 3 of our RMD Tech-1, is that notwithstanding the 2009 RMD waiver, if a participant has elected (or the plan mandates) a series of substantially equal lifetime installments, the Code provides that the installments are not ERDs.(See IRC §402(c)(4)(A).) As a result, if the plan actually distributes the 2009 installment, the apparent ameliorative benefit of the WRERA law change is non-existent. The distribution is taxable and is not eligible for rollover. In contrast, if the same plan decides to suspend 2009 RMDs (or the participant, under the plan’s procedures, elects not to take the distribution), the participant avoids taxation and enjoys the relief that Congress intended. However, there does not seem to be any policy justification for this disparate treatment, which is beyond the control of the participant, and is dependent on how the plan sponsor chooses to comply with the new law. So the question arises whether it would be reasonable for a participant to treat a 2009 distribution, which is an installment payment of only RMD minimums (as in Example 3), as an ERD by reason of the WRERA 2009 waiver provision, even though the distribution technically appears not to be an ERD. In the absence of guidance from the IRS, a conservative answer would be no.

The buzz. A recent informal conversation by a SunGard attorney with an IRS National Office employee indicated that IRS personnel considered whether a distribution similar to that discussed in Example 3 would be eligible for rollover, and the IRS could not reach a consensus on the issue. It is uncertain how and when the IRS might resolve the issue in the future.

The guidance (such as it is). IRS issued Notice 2009-9 to provide guidance to financial institutions regarding the notice to IRA owners subject to the RMD rules that otherwise would be due January 31, 2009. The Notice simply does not address the issues we raise here. Of course, it has been less than a month since the President signed WRERA, and it is likely that the IRS will provide further guidance after they have had more time to consider the issues. We appreciate their willingness to discuss the situation with us.

The options. In RMD-1, we suggested three possible administrative approaches in response to the WRERA RMD law change. In summary, the three are: (1) continue to make distributions that would be RMDs but for the WRERA law change (but provide a notice to participants of the law change); (2) suspend the distributions (but provide a notice that the plan will make the distribution upon the participant’s request; and (3) permit the participant to decide whether to take the distribution (subject to a plan default either to distribute or to suspend, if the participant does not respond). As indicated above, while favorable treatment of a 2009 RMD amount should not depend on whether the plan distributes the amount to the participant, the risk that actual distribution of one of a series of lifetime installments will not be eligible for rollover is significant. Consequently, approach (1) is most likely to result in unwanted tax consequences to the recipient, while approach (2) offers the most tax “protection” to the potential recipient. Note that if a plan uses approach (1) and the recipient individual rolls over a 2009 distribution that the IRS later determines is not an eligible rollover distribution, the individual may withdraw the rolled over amount (with earnings), without penalty, by the due date of the individual’s 2009 income tax return.

The recommendation. In absence of additional guidance, a conservative interpretation of the new law appears prudent. This means practitioners should assume that an RMD that is one of “substantially equal payments” for life, life expectancy, or for a period of 10 years or more is not an ERD, whether the plan makes the distribution pursuant to a participant’s election or pursuant to a plan provision. If the plan’s priority is to offer the most favorable options to participants, the plan should consider either suspending RMDs (subject to the participant’s option to elect to take the distribution), or offering participants a choice, subject to the plan’s “default” either to distribute or to suspend distributions.

The conclusion. SunGard will continue to monitor the IRS’s response, if any, to the 2009 RMD law change, and will communicate with subscribers as the need dictates.