Even those who have already begun receiving required minimum distributions from IRAs and qualified plans may be able to reduce their annual withdrawals–thereby increasing their tax deferral.
On 1/11/01, the Service, without warning, changed the rules for determining required minimum distributions from IRAs, 401(k)s, 403(b)s, and other qualified plans. The new rules are much simpler and substantially reduce amounts that must be withdrawn each year. Thus, IRAs and qualified plans now offer greater opportunity for accumulating wealth. The following is a summary of the new rules in question-and-answer form
Pension plans that make distribution in the form of an annuity and other annuity plans are for the most part not discussed in this article in the interest of simplicity, since the rules for these plans are substantially unchanged. Also (unless otherwise specified), “plan” and “IRA” are used interchangeably in this article, as are “IRA owner,” “owner,” and “employee” since minimum distribution rules for IRAs and individual account plans are the same.
Q. When must I begin taking money out?
A. The required distribution beginning date has not changed. For an IRA owner, member of a Section 403(b) plan (i.e., certain plans of tax exempt organizations and schools), or a 5% owner of a private company maintaining a plan, minimum distributions are first required for the year the plan participant reaches age 701/2, but may be deferred until April 1 of the following year. (This April 1 date is called the “required beginning date.”). Even if the employee delays taking the first year’s distribution until April 1 of the second year, an additional minimum distribution still must be taken for the second year by December 31 of that year. Thus, those who delay taking the first year’s distribution have to take two payments in the second year.
If the employee is not a 5% owner of a company that maintains a qualified plan, the first year a distribution from the qualified plan is required is the year in which the employee retires, if this is later than the year he or she reaches 701/2. (The “required beginning date” will then be April 1 of the following year). In determining whether the 5% ownership threshold is met, shares of a spouse, children, parents, and grandparents are aggregated.
Q. How do I figure how much to take out of my IRA or plan?
A. The new rules are fairly simple while the employee is living. If that person’s spouse is not named as sole beneficiary, or if the spouse is, but is not more than ten years younger than the employee, divide the value of the account at December 31 of the prior year by a divisor for the employee’s age (as of the employee’s birthday in the current year) shown on the table in Exhibit 1. This “uniform table” is the former minimum distribution incidental benefit (MDIB) table, which uses life expectancies of an owner and hypothetical beneficiary ten years younger.
EXHIBIT 1. Uniform table for lifetime distributions
115 and older
Under prior proposed regulations, the MDIB table was available only for an owner and non-spouse beneficiary ten or more years younger than the owner. The MDIB table, transformed into a uniform table, may now be used for everyone, no matter what age the beneficiary is, and even if there is not any designated beneficiary.
Divide the value of each account at the beginning of the year by the applicable divisor to find the total distribution required. In the case of IRAs (but not qualified plans) the required minimum distributions can be taken from any one or more of the IRAs. Inherited IRAs, however, are treated differently. Also, qualified plans cannot be combined with IRAs in determining minimum distributions.
Q. What if the spouse is more than ten years younger?
A. If the employee’s spouse is more than ten years younger, and is the sole beneficiary, the couple’s joint life expectancies under Reg. 1.72-9, Table VI should be used each year in finding the divisor, rather than the uniform table. This will stretch out required minimum distributions even further. The joint life expectancy tables can also be found in IRS Publication 590, which is otherwise now outmoded. (A copy of the IRS publication may be ordered by calling 1-800-TAX FORM.)
Example. Ira is 70 years old. His wife, Iris is age 50. For calculating minimum distributions from Ira’s IRA, the divisor under the uniform table is 26.2; under the joint life expectancy table, it is 34.0. In 2005, when Ira is 74 and Iris is 54, their divisors would be 22.7 under the uniform table and 30.2 under the joint life table. In 2010 (at ages 79 and 59), their divisors would be 18.4 under the uniform table and 25.7 under the joint life tabl
Q. When can an employee start using the new table?
A. Employees can start using the new table in 2001 for IRAs, even if they were already taking required distributions in previous years, and even if the sponsor of the IRA has not amended its plan. The new method may be used for a company-sponsored plan, however, only if the plan is amended
Example. A 75 year old has 16.5 years left for taking minimum distributions from an IRA under the old rules. By switching to the new rules, 21.8 years can now be used in the divisor this year, 20.9 next year, and so on.
Q. Does it matter who the beneficiary is?
A. The beneficiary designated is, of course, very important for an overall estate plan. As explained below, the beneficiary is the key in determining minimum distributions following the employee’s death. The identity of the beneficiary generally no longer matters, however, in determining minimum distributions during the employee’s lifetime. The uniform table now applies to everyone, even to persons who have not named a beneficiary. It does not matter any more for lifetime distributions whether the beneficiary is older, younger, or a charity. The one exception is where a spouse is sole beneficiary and is more than ten years younger than the owner.
Q. Is it still crucial to name beneficiaries by the required beginning date?
A. It is certainly important to name beneficiaries for many reasons, but no longer for determining lifetime minimum distributions. Under the old rules, distributions were fixed in stone based on beneficiaries who were named at an owner’s required beginning date. If no beneficiary had been named at that time, only the owner’s own life expectancy could be used … forever. The beneficiaries who happened to be named on the owner’s required beginning date controlled in fixing minimum distributions under the old rules, even if a different beneficiary actually inherited the IRA.
Q. We used to hear a lot about using or not using a “recalculation method”, “term certain method,” or “hybrid method.” Is this still important?
A. None of these concepts count anymore, and a good thing too. Under the old rules, the “recalculation method” was a trap and sometimes required payment of an owner’s entire IRA in one year after death. This is no longer the case.
Q. How are minimum distributions determined after death?
A. Minimum distributions after death under the new rules are based on those who are beneficiaries on December 31 of the year following the year of death. As a result, life expectancies of actual beneficiaries will now be used. Under the old rules, beneficiaries on an owner’s required beginning date were of key importance.
As before, a spouse may still roll over a death benefit to his or her own IRA, or claim an inherited IRA as his or her own. The new rules clarify that the deceased spouse’s minimum distribution must be taken for the year of death. Although not required for a rollover, a spouse may elect to treat an inherited IRA account as his or her own only if the survivor is sole beneficiary with an unlimited right of withdrawal.
Q. Do the new rules apply to an inherited IRA?
A. Suppose John, a widower, died in 1998 and named Harold, age 35, as his beneficiary. Harold began withdrawing the account over the seven years remaining in 1998 for minimum distributions (under the facts in this illustration) based on the old rules, leaving four years to take minimum distributions in 2001.
If the new rules applied, Harold would have 44.4 years in 2001 to take minimum distributions instead of four. Can he go back and use the new rules? The Service has not decided yet.
Q. Is it too late after death to make any changes?
A Generally it is, since minimum distributions after death depend on who are beneficiaries on December 31 of the year following death. There are still some things that can be done, though, even after death for a better result:
Pay off charities. A single account payable to a charity and other persons poisons the account for everyone. For minimum distribution purposes, the account is not considered to have any beneficiary. This can be avoided by paying the full amount the charity is entitled to before December 31 of the year following death, leaving only real people as beneficiaries on that date.
Divide the account into separate accounts for each of the beneficiaries by the December 31 date. Otherwise, if a single account is held for several beneficiaries and not separated, the age of the eldest beneficiary must be used in determining minimum distributions for all of the beneficiaries.
Change the beneficiary by disclaimer. A disclaimer is a refusal to accept a bequest or benefit. If made with certain formalities required by Section 2518 within nine months following death, the account will be treated as though it were left initially to the contingent beneficiary.
Q. Can a trust be named as beneficiary?
A. It depends on the plan. The proposed regulations are concerned with only required minimum distributions. A trust can never by itself be a “designated beneficiary.” The new proposed regulations, however, allow under certain conditions, looking through the trust to the trust’s own beneficiaries, and using their life expectancies in determining minimum distributions.
The regulations reaffirm that beneficiaries of a testamentary trust, as well as those of a revocable, or irrevocable inter vivos trust, may qualify as designated beneficiaries in fixing minimum distributions. The new regulations also affirm several letter rulings which found that remaindermen of a QTIP trust, in addition to the spouse, were designated beneficiaries if the trustees had authority to accumulate part of minimum distributions in the trust (e.g., when minimum distributions are attributable in part to principal). This can cause a problem if a charity or other beneficiary who is not a real person is named as a remainderman. In that case, the plan is not considered to have any designated beneficiary.
In order to look through a trust to its own beneficiaries:
1. The trust must be valid under state law (or would be valid but for lack of corpus).
2. The trust must be irrevocable, or will be irrevocable at death.
3. The beneficiaries of the trust must be identifiable.
Also, the documentation described below must be provided to the administrator or IRA custodian.
Documentation during lifetime
No documentation is generally required during the employee’s or account owner’s lifetime, unless a spouse is sole beneficiary of the trust named as beneficiary (so that joint life expectancies are used in determining minimum distributions instead of the uniform table). In this latter case, documentation requirements can be satisfied in one of two ways:
1. Furnish a copy of the trust agreement to the plan administrator (or IRA custodian), together with the employee’s (or IRA owner’s) written agreement to provide, within a reasonable time, a copy of each amendment
2. Furnish the plan administrator (or IRA custodian) with (a) a list of all beneficiaries of the trust (including contingent beneficiaries and remainderman) and with a description of the conditions of their entitlement, together with (b) the employee’s (or IRA owner’s) certification that to the best of the employee’s (or IRA owner’s) knowledge the list is correct and complete, and that the other general requirements applicable to trusts are satisfied (i.e., requirements above as to validity, irrevocability, and identification of beneficiaries).
Documentation after death
Documentation requirements after death may again be satisfied by furnishing either of the following to the plan administrator (or IRA custodian) by December 31 of the calendar year following the year of the employee’s (or IRA owner’s) death:
1. A copy of the actual trust agreement.
2. (a) A final list of all trust beneficiaries (including contingent beneficiaries and remaindermen) with a description of their entitlement and (b) the trustees’ certification that to the best of the trustees’ knowledge, the list is correct and complete, and that the other general requirements applicable to trusts (i.e. validity, irrevocability, and identification of beneficiaries) are satisfied. The trustees must also agree to provide a copy of the trust agreement on demand.
Q. Does it matter whether death is before or after the required beginning date?
A. Generally the results will be the same, i.e., minimum distributions will be based on life expectancies of beneficiaries on December 31 of the year following death. In two situations, however, it matters whether death is before or after an employee’s or IRA owner’s required beginning date.
1. If there is no designated beneficiary and death is before the employee’s or IRA owner’s required beginning date, the full account must be paid out by December 31 of the year of the fifth anniversary of death. If, on the other hand, the employee or owner dies without a designated beneficiary after the employee’s or owner’s required beginning date, minimum distributions may continue over the employee’s or IRA owner’s remaining life expectancy.
2. Suppose an employee or IRA owner dies before the required beginning date and is survived by a spouse who is beneficiary. In that situation, a spouse who does not roll the account over to his or her own IRA, or claim the account as his or her own, may defer taking distributions until December 31 of the year the employee or owner would have reached 701/2. If the surviving spouse subsequently dies before being required to begin distributions, the account will be treated as though it were the spouse’s own (and payment will be made to the spouse’s beneficiaries using their life expectancies).
Exhibit 2 contains a chart of these complicated rules.
EXHIBIT 2. Minimum distributions requirements following death of an IRA owner
|Death before required beginning date||Death after required beginning date|
|Non-spouse beneficiary||Use life expectancy of beneficiary in year following owner’s death; reduce by “1” for each later year.||Use life expectancy of beneficiary in year following owner’s death; reduce by “1” for each later year.|
|Spouse beneficiary and does roll over to own IRA|
|a. Owner reached 70 1/2||Spouse’s life expectancy is redetermined each year, up to and including year of spouse’s death. For later years, use spouse’s life expectancy in year of spouse’s death and reduce by “1” for each later year.|
|b. Owner less than 70 1/2||Distributiuons need not begin until later of 12/31 of year following owner’s death or of year owner would have been 70 1/2. Distributions then continue as in last column for “a” above|
|No designated beneficiary||Account must be paid out by 12/31 of year of fifth anniversary of owner’s death.||For years after owner’s death, use owner’s life expectancy for year of death and subtract “1” in each later year.|
Q. Are there any new planning opportunities available for a widow or widower?
A. For one, consider naming a grandchild as beneficiary. (Make sure to use a trust if the grandchild is a minor, or if the grandchild is below a minimum age the widow or widower feels is necessary for the grandchild to have complete control.) This could have been done before, but changing beneficiaries after the first spouse died was usually too late to affect minimum required distributions (i.e., when the spouse died after the owner’s required beginning date)
Example. A trust for a 15-year-old grandchild is named as beneficiary of a $10,000 IRA. The grandchild has a life expectancy of 66.8 years and can be expected to receive distributions of more than $75,000 during his lifetime, even with an interest rate of only 5% (assuming estate tax on the $10,000 when the grandparent dies is paid from another source).
Q. Should married couples change their IRA planning?
A. For the reasons above, consider using all or part of the estate tax exemption (currently $675,000) on the first death for grandchildren, but only to the extent the survivor will have sufficient other funds to live comfortably. It is not too late to use grandchildren’s life expectancies to stretch out minimum distributions after death to as much as 60 years or more, even for IRA owners who are past their required beginning dates. That is because minimum distributions after death under the new rules are based on life expectancies of beneficiaries on December 31 of the year following death (rather than on the required beginning date, as previously). For instance, $675,000 set aside for a 15-year-old grandchild will produce over $5 million during the grandchild’s lifetime, with an interest rate of only 5%.
Using an IRA in this way can be accomplished by naming a trust as beneficiary for grandchildren who are minors, or who are below an acceptable age for complete control (e.g., 25 or 30). The trustee will be able to use the IRA for the beneficiary’s needs while the trust is in existence. The new proposed regulations now provide assurance that a testamentary trust may be used.
A flexible arrangement might be to name a spouse as beneficiary, but provide that any part the spouse disclaims will pass to the trust for grandchildren. In that way a survivor can assure his or her own needs after the first spouse dies, and will have up to nine months after the first death to decide how much to disclaim.
When leaving the entire estate tax exempt amount for grandchildren is not feasible, part (or all) of an IRA or pension account can be used to fund a trust for the survivor, either directly or by way of a disclaimer. Assets other than pensions or IRAs are better suited for this purpose, however.
Q. Can an estate be named as beneficiary?
A. Most plans will allow naming an estate as beneficiary, but it still is not advisable. An estate is still not considered a “designated beneficiary” for minimum distributions purposes, has no life expectancy, and will sharply accelerate required minimum distributions after death.
Q. How will large corporate plans be affected by the new regulations?
A. Both the old and new rules pertain to minimum distributions. A plan may require faster payouts to avoid administrative burdens. If that is the case, consider rolling over benefits to an IRA as soon as the law and plan allow.
Q. What about plans of sole proprietors, partnerships, and small businesses?
A. The problem is that these plans can last only so long as the enterprise is in existence. In these situations, the right to extended minimum distributions is illusory. Consider rolling over to an IRA as soon as possible.
Q. How will the Service enforce minimum distribution requirements?
A. The new rules provide for a system of reporting in the case of IRAs. Forms similar to Form 1099 will be required of IRA custodians and trustees.
The new rules, although in the form of proposed regulations, can be relied on in 2001. A public hearing is scheduled for 6/1/01 and hopefully final regulations will be adopted shortly afterwards. Proposed minimum distributions regulations were first published in July 1987 and controlled minimum distributions until now.
The new proposed regulations are much simpler than the previous rules and should benefit most people. Hopefully, final regulations will allow persons now taking distributions from inherited IRAs to use the new rules and substantially reduce their required minimum distributions.