State Bar of Wisconsin

Vol. 74, No. 9, September 2001

Simplified Rules on IRA and Retirement Plan Distributions

Sidebars:

• Minimum Annual Distribution Table

by Andrew J. Willms & Jason R. Handal

ince 1987, the rules governing IRAs and qualified plan ("retirement account") distributions have been contained largely in proposed regulations that have been difficult to interpret, and thus the source of much controversy.

The Proposed Regulations would eliminate much of the complexity currently surrounding retirement account distributions by 1) making it easier for account owners to calculate the amount they must withdraw during life, and 2) delaying the determination of the account's designated beneficiary for tax purposes until the end of the year following the year of the account owner's death. Ultimately, the Proposed Regulations will reduce the amount of required distributions for the majority of taxpayers.

Effective Date

The new Proposed Regulations are effective no later than Jan. 1, 2002. However, IRA owners may, but need not, apply them as of Jan. 1, 2001, notwithstanding the terms of the IRA documents. Further, plan sponsors may, but need not, follow the Proposed Regulations by adopting the model amendment provided in the regulations (as amended after original issuance in the Federal Register on Jan. 17, 2001) before Dec. 31, 2001.

The IRS already has issued clarification regarding the effective dates. Specifically, the preamble to the new Proposed Regulations provides that taxpayers may rely on either the 1987 Proposed Regulations or on the 2001 Proposed Regulations when determining required minimum distributions for calendar year 2001. The clarification provides that for purposes of determining what constitutes a "2001 distribution," a distribution for calendar year 2001 does not include a distribution that is required to be made by April 1, 2001, for calendar year 2000, such as for an account owner/plan participant who attained age 70-1/2 in 2000. The amount of such a distribution must be determined under the 1987 Proposed Regulations.

What the Regulations Say

The principal provisions of the Proposed Regulations are summarized as follows:

1) The Proposed Regulations contain a simple, uniform table that can be used by all account owners when determining the minimum amount that must be withdrawn annually from the account prior to death. That table is included at the end of this article.

• Use of the table allows distributions to be based on the joint life expectancy of the account owner and a hypothetical person who is 10 years younger than the account owner.
• Minimum required distributions are determined without regard to the beneficiary's actual age (except as provided below).
• The only exception would occur when the required distributions could be reduced. This would apply only when a spouse who is more than 10 years younger than the account owner is the designated beneficiary. In this case, the actual joint life expectancy of the account owner and the spouse can be used. This could benefit the account owner, as it would allow him or her to slow down the rate of required distributions during his or her lifetime.
• It no longer will be necessary to decide whether or not to recalculate life expectancy when determining the amount to be distributed. This has been a complicated and difficult decision for account owners.
• The new Proposed Regulations are much simpler, and more favorable, than their predecessors.

2) The new Proposed Regulations eliminate the requirement that the designated beneficiary for purposes of minimum distributions be determined as of the account owner's required beginning date (typically April 1st of the year after the owner attains age 70-1/2).

• In the past, the life expectancy of the designated beneficiary determined the rate of distributions from that point forward. A change of beneficiary after the required beginning date to a younger beneficiary would not affect the rate of distributions.
• Now, determination of the rate of distributions can be delayed until Dec. 31 of the year following the account owner's death.
• In most cases, the beneficiary's life expectancy will determine the rate of distributions after the account owner's death. This makes sense; however, the prior rules were quite complicated as to determining the rate of post-death distributions.
• A change during life and after the required beginning date to a beneficiary with a shorter life expectancy, or no life expectancy (that is, a charity), will not increase the rate of lifetime distributions, as was the case under the prior regulations.
• A change of beneficiary after the required beginning date now will be effective to promote a "stretch-out" of distributions after the account owner's death.
• The later determination date offers additional post-death planning opportunities through the use of qualified disclaimers.

3) The date the rules take effect depends upon the circumstances.

• For a participant in a 401(k), profit sharing plan, or other type of qualified plan, the new rules will take effect no later than 2002, although the plan sponsor (that is, employer) may allow retirees to begin using the new rules in 2001.
• An IRA account owner can use the new rules to determine the required distribution amount for 2001.
• If an individual turned 70-1/2 last year and has waited until this year to receive his or her minimum distribution for 2000, then the old rules must be used for that distribution, but the new rules can be used for the 2001 distribution.
• In the case of an individual who has inherited an IRA or retirement plan from a person who died before 2000, it is not entirely clear how much the beneficiary is required to withdraw.

4) The Proposed Regulations also change the rate of distributions following the account owner's death if there was no designated beneficiary.

• If the account owner dies before his or her required beginning date and there is no designated beneficiary as of the end of the year following death, then the entire plan balance must be distributed by Dec. 31 of the year containing the fifth anniversary of the account owner's death. This is consistent with the prior rules.
• If the account owner dies after his or her required beginning date and there is no designated beneficiary as of the end of the year following death, then the person(s) receiving the account can consider the account owner's remaining life expectancy at the time of death, which might allow for greater deferral of distributions to the beneficiary(ies).

5) Where a trust is the designated beneficiary, the requirement that a copy of the trust document be provided to the "plan administrator" before the required beginning date is eliminated, subject to certain limited exceptions.

Estate Planning Implications

These changes will significantly affect estate planning for retirement accounts. Some of the possible ramifications of the new Proposed Regulations include:

1) There is no need to decide whether to recalculate life expectancies.

2) If a spouse who is named as the primary beneficiary of a retirement account dies first, the account owner simply can change the designated beneficiary, and the new beneficiary's life expectancy will determine the rate of minimum distributions after the account owner's death, even if the change occurs after the account owner's required beginning date.

3) As a result of #2 above, second-to-die life insurance will be a much more feasible way to pay estate taxes on retirement accounts.

4) If the designated beneficiary makes a qualified disclaimer (that is, rejection of ownership) of account benefits, and as a result the benefits pass to a person with a longer life expectancy, then the longer life expectancy can be used when determining the rate of distributions after the account owner's death. As a result, it will be important to draft beneficiary designations that include younger persons (such as grandchildren) as alternate beneficiaries.

What Account Owners Should Do

1) If an account owner is over age 70-1/2 and therefore is receiving minimum distributions, then:

• He or she should not take his or her minimum required distribution for 2001 until he or she is certain the new table is being applied. This will, in most cases, ensure the distribution is no larger than required.
• Remember, the account owner can always withdraw more than the required amount. In most cases, of course, the account owner will have to pay income tax on such a withdrawal.
• Account owners should review their current beneficiary designations to ensure they are taking advantage of the new proposed rules. The simpler, more lenient rules have created opportunities to ensure that the tax-deferred funds continue to be tax-deferred for as long as possible after death.

2) Because the required distribution will be lower, this could reduce certain individuals' 2001 adjusted gross income to less than $100,000, thereby making him or her eligible to convert a traditional IRA to a Roth IRA, if he or she is otherwise interested in doing so.

3) In the case of an inherited IRA or retirement account from a person who died during 2000 or before, consider delaying the 2001 distribution until the impact of the new rules has been clarified.

Conclusion

While questions remain and further guidance is expected, the new Proposed Regulations will simplify distribution planning from retirement accounts as well as increase an account owner's ability to defer the income tax liability attributable to such accounts. Further, the Regulations, in most cases, will allow beneficiaries to withdraw the funds more slowly after the account owner's death. As a result, all account owners should review their beneficiary designations to ensure they are taking advantage of the newly proposed rules.

To view the entire text of the Proposed Regulations (and subsequent IRS clarifications), visit the "estate planning in depth" section of www.estatecounselors.com.

Wisconsin Lawyer