Grim, Biehn & Thatcher
On January 11, 2001, IRS issued new proposed regulations applicable to required minimum distributions (RMDs) from IRAs and other retirement plans. (On January 17, minor amendments were enacted, mainly to clean up some of the language.) The new rules greatly simplify planning for distributions to employees and IRA owners from retirement plans. While IRA owners may begin using the new rules immediately, pension plan participants must wait until their plans are amended to begin calculating MRDs under the new more liberal rules.
[NOTE: These new regulations are still in the “comment period”. Therefore, certain provisions are subject to interpretation, clarification and change.]
In planning for distributions from retirement plans, the name of the game– for taxpayers who don’t actually need the plan assets– has been deferral: since assets remaining in a plan grow tax-free and since distributions from most plans are taxable when received, the object of distribution planning has been to keep IRA or plan assets in tax-exempt “solution” for as long as possible and take the smallest distributions allowable without being subject to penalties for not taking enough (the RMD) out of the plan. Taxpayers would often select younger beneficiaries in order to take advantage of longer joint life expectancies and thereby extend the payout period (but if the selection occurred after a taxpayer’s required beginning date, the selection would not result in an extension of the payout period– one of the “gotchas” that has been eliminated by the new rules). The longer the payout period, the smaller the required distributions. Taxpayers could also elect to recalculate their life expectancies every year in order to extend the payout period and reduce their MRDs-but this would not be effective in the event a non-spouse beneficiary was selected.
The new rules remove most of the uncertainty and give most taxpayers the benefits of the rules that previously only some taxpayers could get through careful planning and execution.
MRDs are calculated by dividing the amount in the retirement account by a life expectancy factor called the “divisor”. Under the old rules, the divisor used by a benefit recipient depended on (i) the identity of the recipient’s designated beneficiary on the “required beginning date” (RBD) (generally, the end of the calendar year following the year in which the participant reached age 70 1/2), and (ii) the method chosen (fixed term, joint recalculation or “split” method) by the participant to determine her (or her and her spouse’s) life expectancy. Which of these methods was the best sometimes depended on events occurring after the distributions began, at which time it was too late to make a meaningful change. And while beneficiaries could be changed after the RBD, a change made after the RBD (to a younger beneficiary, for example) would not result in a recalculation of the MRD.
The new rules simplify the choices and liberalize the treatment of plan participants in several major ways:
- A new “Uniform Table” applies to distributions at or after the RBD. The divisors in the Uniform Table represent the joint life expectancy of a 70-year old (or older) participant and a beneficiary who is 10 years younger than the participant. This is the best deal possible under the old rules, and was generally only available to a participant who named a younger generation beneficiary on or before the RBD. Under the old rules, a participant naming her close-in-age spouse would be had to use a smaller divisor than is now provided under the Uniform Table. The result was larger required distributions, less tax deferral, and fewer assets remaining in the plan for retirement needs. The new rules allow everyone to use the divisor resulting in the greatest amount of deferral, and allow a participant to select a beneficiary based on traditional factors-e.g. who does the participant wish to have the use of the money- instead of choosing the post-death beneficiary whose selection would result in the smallest required distributions during the participant’s lifetime.
Note that in the case of a participant with a significantly (more than 10 years) younger spouse who is the sole designated beneficiary, the participant may base distributions on the actual joint life expectancy, which will yield a divisor larger than that provided in the Unified Table.
In either case (the Unified Table or the “much younger spouse” rule, the recalculation method is now mandatory. This method generally results in smaller required distributions and a longer lasting retirement account.
- The life expectancy of the beneficiary who actually inherits the retirement assets will be used to measure required distributions beginning at the death of the plan participant. Under the old rules, many beneficiaries who inherited retirement plans or IRAs could not actually use their life expectancies to calculate their RMDs for various reasons, including the failure to designate the beneficiary prior to the RBD, the change of the beneficiary after the RBD, the selection of a much younger beneficiary, etc.. Under the new rules, the required distributions to the beneficiaries who actually inherit the plan assets are -for the first time- based on the life expectancies of the beneficiaries who actually inherit the plan assets. This calculation will no longer required looking back to see who the designated beneficiary was at the participant’s RBD. The identity of the designated beneficiary will, under the new regulations, be determined “based on the beneficiaries designated as of the last day of the calendar year following the calendar year of the employee’s death.” Under this rule, a person who was a beneficiary on the date of the employee’s death but is not a beneficiary as of the later date (perhaps because of a disclaimer or because the person took her share of the plan benefit before the later date) is not treated as the beneficiary for purposes of determining the applicable RMDs. This rule will make post-mortem planning opportunities more important than they were under the old rules-for example, qualified disclaimers, establishment of separate accounts for plan proceeds where there is more than one beneficiary, and making early post-death distributions to older beneficiaries will be important tools in minimizing required minimum distributions to beneficiaries.
By the way, the regulations clearly state more than once that an estate cannot be a designated beneficiary. This rule probably also applies to trusts that do not meet specified requirements to be designated beneficiaries. The regulations imply, but do not specifically state, that this problem can be cured by simply distributing, to the estate or the beneficiaries of the non- qualifying trust, the appropriate share of the plan benefits prior to the end of the year following the participant’s death. If, following such a distribution (or distributions), the only beneficiaries are permitted individuals, the defect would appear to have been cured.
Although the new rules are expected to be effective for MRDs taken on or after January 1, 2002, IRA owners may choose to have the new rules apply to MRDs taken in 2001.
While the new rules will generally result in smaller required distributions, there are some circumstances in which using the new rules will not result in the smallest possible distributions. Taxpayers should consult with their advisors to determine which method to use for 2001 and later distributions.