The IRS recently issued proposed regulations that fundamentally change the methods for computing required distributions from qualified retirement plans and individual retirement accounts (IRAs). The proposed regulations also greatly simplify the rules for naming account beneficiaries. The proposed regulations replace a previous set of proposed regulations that had been in force since 1987. This On the Subject release describes the fundamental changes made by these rules and how they affect our clients’ estate plans.
Highlights of the Proposed Regulations
The most important change made by the IRS in the proposed regulations was to greatly simplify the method for computing minimum required distributions. Tax law requires persons who have reached their "required beginning date" or "RBD" (usually age 70 ½) to draw down balances in their retirement accounts by taking at least the "minimum required distribution" each year. Absent a drawdown requirement, taxpayers would have an incentive to leave their retirement account balances in the plan for as long as possible to obtain maximum tax-free growth and deferral of income tax.
Minimum required distributions are determined by dividing the value of the participant’s account (revalued each year) by a life expectancy factor. Under the old regulations, the computation of the proper life expectancy factor depended on the interplay of several components, including the participant’s age, the age of the participant’s designated beneficiary, if any, when the participant selected that beneficiary and the method selected to determine life expectancy. As a result, there were seven possible ways to determine the factor. The new proposed regulations eliminate almost all of this complexity by adopting a uniform table for computing the applicable factor. The table derives the factor from actuarial data based on the joint life expectancy of the participant for his or her age and a person 10 years younger. The uniform table is reproduced at the end of this On the Subject.
The table "recalculates" the joint life expectancy every year. Thus, as long as the account owner lives, application of the factor against the account balance will not result in the exhaustion of the account. The owner, of course, may withdraw all assets from the account at any time after he or she reaches age 59 ½, although doing so will trigger the recognition of income tax on the additional withdrawal.
Only in one circumstance can the account owner depart from the uniform table in computing minimum required distributions. If the owner’s spouse is more than 10 years younger than the owner and the owner names the spouse as a designated beneficiary of the account, the owner can use the actual joint life expectancy of the owner and his or her spouse to compute minimum required distributions. Because the uniform table assumes the owner’s beneficiary is only 10 years younger than the owner, this alternate method for clients with spouses more than 10 years younger will reduce the size of the owner’s minimum required distributions.
The IRS has proposed to make the new regulations effective for calendar years after 2001. However, IRA owners can calculate their minimum required distributions for 2001 using the new rules. Qualified plan participants receiving distributions can only use the new rules for 2001 if their plans are amended. A participant should check with his or her employer to determine if such an amendment will be made.
The IRS’s adoption of the uniform table greatly simplifies the naming of a designated beneficiary by the account participant. Under the old regulations, the size of a participant’s minimum required distribution depended on, among other things, the age and identity of the participant’s beneficiary. Choosing the "wrong" beneficiary could accelerate required distributions during the participant’s life. For instance, if the participant named a charity as a beneficiary, he or she was treated as not having a designated beneficiary at all, which forced the participant to use his or her single life expectancy to measure distributions. Furthermore, if a participant who had passed his or her required beginning date changed his or her beneficiary, this action could increase the size of his or her minimum required distributions.
The proposed regulations eliminate difficult decisions in naming a beneficiary by allowing everyone to use the uniform table. Under the proposed regulations, the identity of a beneficiary is almost always irrelevant to computing a minimum required distribution. Thus, a participant can name a charity, a trust or an individual without inadvertently increasing his or her minimum required distributions. The uniform table also effectively allows a participant to change his or her beneficiary from time to time without changing the way in which the minimum required distributions are computed. To this extent, traditional estate planning considerations, rather than income tax considerations, may assume more importance in designating a beneficiary of a retirement account.
How Do the New Regulations Affect You?
As mentioned, if you are a participant in a qualified retirement plan, the new rules will only be available this year if the plan is properly amended. Should you take any action this year with respect to your IRA as a result of the proposed regulations? As a practical matter, you should take action only if you are past your required beginning date or turned age 70 ½ last year and will reach your required beginning date April 1, 2001. If you have not yet reached your required beginning date, you need not take minimum required distributions. To this extent, the proposed regulations will not really affect you. As long as you have reached age 59 ½, you remain free to take out as much or as little from your IRA as you like.
On the other hand, if you have reached your required beginning date or will reach it this year, you can use the uniform table for computing your year 2001 minimum required distribution from your IRA. The IRA custodian or trustee need not amend its IRA account agreement with you for you to use the new table. If you prefer, you can still use the method you used last year for 2001. As mentioned, the IRS suggests that the proposed regulations will be mandatory for distributions taken in 2002 and thereafter.
If you have reached your required beginning date and have already named a beneficiary, you can now change that beneficiary designation without affecting the size of your minimum required distributions. If your current beneficiary designation is inconsistent with your estate plan, you may wish to consider changing it. The importance of having a proper designated beneficiary and the estate tax implications thereof are not affected by the new proposed regulations. If you have selected two or more beneficiaries, special planning may also be necessary to ensure that the most favorable time period for their receipt of post-death distributions is available.