Understanding RMDs for Your ESOP Account & New Life Expectancy Tables for 2022

Thoughtware Alert Published: Feb 22, 2022
Commercial Services

Many employee stock ownership plan (ESOP) participants don’t understand required minimum distribution (RMD) requirements due to their infrequent nature. RMDs come with rules that must be followed, and it’s the participant’s responsibility to be aware of them. Taking a moment to fully analyze the basics of an RMD as listed below will help educate participants on their responsibilities. 

What’s an RMD?

The RMD rules, contained in Internal Revenue Code Section 401(a)(9), set the latest date that ESOP benefits must begin to be paid. These RMD rules are in place to ensure that participants use tax-deferred qualified retirement plans (including ESOPs) to pay retirement benefits and not as an estate planning tool. In general, an RMD is the minimum distribution that a participant must take from his or her ESOP account when reaching the age of 70 1/2 (if you were born before July 1, 1949) or age 72 (if you were born after June 30, 1949) or, if later, the calendar year in which the participant terminates. However, if the participant was age 72 (70 1/2 if reached 70 1/2 before January 1, 2020) and owned a 5 percent interest in the plan sponsor at the time of the ESOP transaction, the participant must take an RMD regardless of termination. Participants may not elect to defer an RMD, and the RMD may not be rolled over into an IRA or another retirement account. 

When Are You Required to Take Your First RMD?

Benefits under an ESOP must begin to be distributed by the “required beginning date” (RBD). The RBD is April 1 of the calendar year following either 1) the calendar year in which the participant attains age 70 1/2 (if you were born before July 1, 1949) or age 72 (if you were born after June 30, 1949) or 2) the calendar year in which the participant severs employment, whichever is later. After the first distribution, the participant will have until December 31 of each year to take the RMD. The participant isn’t limited to that sole amount. A participant can withdraw more without a penalty, but the excess amount can’t be used to lessen the next year’s RMD. 

How Is the RMD Calculated?

In general, RMDs are calculated by dividing the ESOP account’s prior year-end balance by the applicable life expectancy factor. The IRS publishes a life expectancy table each year in Publication 590. While the custodian or plan administrator typically calculates the RMD, it’s important the participant understands he or she is ultimately responsible for calculating the correct RMD amount. 

The table used to determine the RMD will be dependent as follows: 

  • Joint and Last Survivor Table – The sole beneficiary of the account is the spouse, and the spouse is more than 10 years younger than the participant.
  • Uniform Lifetime Table – The sole beneficiary isn’t the participant’s spouse, or the participant’s spouse isn’t more than 10 years younger than the participant.
  • Single Life Expectancy Table – The beneficiary of the account is the participant.

New RMD Life Expectancy Tables for 2022

On November 12, 2020, final regulations were published in the Federal Register in accordance with the Executive Order 13847. The Treasury Department and the IRS released updates to the life expectancy and distribution period tables for RMDs. These new life expectancy tables take into account the increase in life expectancy among Americans, resulting in smaller annual distributions and longer payouts of account balances. These changes will take effect for distribution calendar years beginning on or after January 1, 2022. For those with an RBD of April 1, 2022, the account holder will use the old life expectancy tables to calculate the RMD due. However, the new life expectancy tables will be used for RMDs due by December 31, 2022.

Example 1: In 2022, John becomes 72 and terminates employment. As of December 31, 2021, his ESOP account had a prior year-end balance of $200,000. Because John is age 72 and terminated employment, his first RMD is due by April 1, 2023. According to the newly revised RMD table, John’s applicable life expectancy factor would be 27.4, and his RMD due by April 1, 2023, would be $7,299.27. This is determined by dividing his prior year-end balance of $200,000 in his ESOP account by the applicable life expectancy factor of 27.4. Under the old tables, his life expectancy factor would be 25.6. With the newly revised 2022 table, his new life expectancy factor increased from 25.6 to 27.4, and his RMD would be reduced by $513.23. The slight modifications imposed by the rule change would qualify John for a lower RMD under the new IRS guidelines.

Example 2: Same example as above but John turns 72 and terminates employment in 2021 (a year earlier). His first RMD is due by April 1, 2022. John would use the previous life expectancy tables to arrive at a 25.6 life expectancy factor. His RMD would then be $7,812.50. Going forward, the next RMD must be taken by December 31, 2022, and will use the updated life expectancy tables.

What Happens If You Fail to Take the RMD?

Participants who fail to withdraw the full amount that’s required or fail to take an RMD will incur stiff penalties. The IRS currently imposes a 50 percent tax on the distribution amount not taken. The participant will file a Form 5329 along with his or her Form 1040. The penalty can be waived if the participant can prove the shortage resulted from a reasonable error and that steps are being taken to fix the shortage. A letter of explanation must be attached to Form 5329 to qualify.

How Are RMDs Taxed?

Currently, an RMD is taxed at the participant’s ordinary income tax rate.  

If you have questions on whether you’re required to take an RMD from your ESOP account this year or need assistance computing your RMD, reach out to your BKD Trusted Advisor™ or ESOP administrator or submit the Contact Us form below. 
 

Related Thoughtware

Kate & Ben — How can we help you? Contact Us!

How can we help you?