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DisclaimerGeorge Coughlin is NOT
responsible for, and cannot control the content of, the material listed in “Other
Resources” below. In fact, those
reference items, software programs and web sites may provide incorrect information,
produce inaccurate results or make false statements.
Furthermore, any investment or insurance advice as well as recommendations
to purchase or sell securities you receive from a resource listed on IRAplanning.com does
NOT involve George Coughlin or his broker/dealer ePLANNING Securities, Inc. Please use appropriate caution. 2002 Rules of the Road
The final regulations on required distributions published by the Service on April 17, 2002 apply to both defined contribution and defined benefit plans under §401(a). They also impact individual retirement accounts and individual retirement annuities under §408. In addition, they cover §403(b) tax sheltered annuity (TSA) contracts purchased, or custodial accounts or retirement income accounts established, by a §501(c)(3) organization or public school. Lastly, the 2002 rules pertain to required distributions from certain deferred compensation plans for employees of state and local governments under §457(d)(2). It is important to remember that a Roth IRA provides several significant exemptions from IRC §401(a)(9). The first is an avoidance of required distributions during the owner’s lifetime. That is to say, Roth IRA’s are immune from IRC §401(a)(9)(A). They are also exempt from the Minimum Distribution Incidental Benefit provisions of IRC §401(a). Furthermore, Roth IRA’s are not impacted by IRC §401(a)(9)(B)(i) when the owner dies. Instead, beneficiaries need only adhere to the relatively straightforward procedures of IRC §401(a)(9)(B)(ii) and (iii). Essentially, those are the same rules that apply to non-spouse beneficiaries when traditional IRA owners die before their required beginning date. That means beneficiaries have only one set of rules to follow regardless of the age of the Roth IRA owner on his/her date of death.
Why Were The Minimum Distribution Rules Created? Simply put, money set aside and accumulated in qualified retirement plans is granted favorable tax treatment with the expectation that it will be used for retirement income purposes. To curtail one potential abuse of that opportunity, Congress decided to set duration limits on the tax deferral aspect of all qualified retirement plans. IRC §401(a)(9) is the mechanism to accomplish that objective. Under the guidelines contained in that paragraph, everyone is forced to begin making withdrawals at a prescribed level from all their retirement plans at a specified date even if they do not need the extra revenue and/or would prefer to leave the capital in their respective plans.
Do The Rules Come Into Play and How Do They Operate? A. Unless a limited exception applies (see page 6), the “living” aspects of the required distribution provisions found in IRC §401(a)(9)(A) kick into gear during the year a participant reaches age 70˝. 1. Technically speaking, the withdrawal for the first distribution calendar year may be delayed until April 1 of the year immediately following the year in which someone attains age 70˝. That date is referred to as their Required Beginning Date or RBD. [§401(a)(9)(C)] Please follow the hyperlink in the preceding sentence for a complete definition of “RBD” -- including an exception for certain participants. At the same time, be sure to double check the definition of “distribution calendar year”. 2.
If the taxpayer elects to delay making the minimum withdrawal for the first
distribution calendar year until sometime between January 1 and April 1 of the year after
they reach age 70˝, they are still required to make a minimum distribution from their
qualified plan for the second distribution calendar year not later than December 31 of the
year they attain age 71˝. Therefore, the
election to delay the first year’s payment forces two taxable distributions to occur
in a single year -- the year they turn age 71˝. [§1.401(a)(9)-5,
A-1(c)] 3.
Rules similar to those outlined in the previous paragraph also apply to a select
group of participants who may delay their RBD until the year after they retire, if
retirement follows the year they attain age 70˝. (For
more details, please refer to the discussion of “Required
Beginning Date”.) Those special
retirees must take a required distribution from their plan for the year in which
they retire – their first distribution calendar year.
That withdrawal for the initial year may be delayed until April 1 of the year
following the year they retire from employment with the employer maintaining the plan. Such a delay, however, does not relieve the
participant of the need to also take a minimum required distribution for the year
following their retirement – their second distribution calendar year. [§1.401(a)(9)-2, A-2(a)] 4.
A further delay is possible for the pre-1987 portion of tax-sheltered annuity plans (TSA’s) covered
under IRC §403(b). Please note, however,
that all post-1986 earnings and contributions are subject to the normal required
distribution rules. [§1.403(b)-3, A-3] B.
The
same paragraph of the Internal Revenue Code that mandates lifetime withdrawals also
stipulates the minimum distributions that must be carried out following the death
of a participant. The postmortem
rules break down into two subcategories depending on when the participant dies. 1.
If death takes place before the required beginning date, the
final regulations closely parallel the provisions of the 2001 and 1987 proposed
regulations. It should be noted, however,
that if the account has a Designated Beneficiary, the default method in the final
regulations is the life expectancy rule, referred to below as the General and Spousal
Exceptions. In the 1987 proposed regulations,
the Five-Year Rule served as the default. Under
certain circumstances, that subtle shift can have a favorable impact on beneficiaries that
are otherwise eligible to use the General Exception but failed to meet the requisite
deadline to commence those distributions. See
item
“S” in the Assorted Planning Pointers for more details. a)
Although
a qualified retirement plan, IRA or TSA is permitted to be more restrictive, the first
option under the new rules allows assets in those qualified plans to be withdrawn at
anytime during the period that ends on December 31 of the fifth year following the year of
the participant’s death. [§401(a)(9)(B)(ii)]
b)
There is a General Exception to the Five-Year Rule available for any portion of the
participant’s interest in the account payable to someone who qualifies as a “Designated Beneficiary”. (Please read the definition of that term as well
as the discussion of separate accounts.) A sole Designated Beneficiary (DB) may elect to
pull assets out of the plan over his or her own life expectancy, or a shorter period,
provided those withdrawals begin by the end of the year immediately following the year of
the participant’s death. The tax code
also allows one heir in a group of Designated Beneficiaries to receive his/her share of
the plan over the life expectancy of the oldest DB even though the other members in the
group take 100% of their share immediately. If
the qualified plan is broken into separate accounts, the DB of each separate account may
use his or her own life expectancy when computing required distributions. [§401(a)(9)(B)(iii)] c)
The Spousal Exception to the Five-Year Rule offers a surviving spouse even greater
flexibility than the general exception. [§401(a)(9)(B)(iv)] Provided the participant’s spouse is the sole
Designated Beneficiary of the entire qualified plan or a separate account within that
plan, distributions must commence by the later of the date specified for the General
Exception or the end of the calendar year in which the employee would have attained age
70˝. (Please refer to the discussion of separate accounts.) d)
The flow chart on Table 22 entitled
“Tax Rules Governing Postmortem Distributions From Qualified Plans” spells out
the details of the preceding options. Table 26 illustrates the potential value of
stretching out distributions using the General Exception.
Please note that qualified plans can restrict a beneficiary’s options. A review of those restrictions begins later in
this document under the heading “Can The Qualified Plan
Limit Your Planning Options?” 2.
If the participant dies on or after the RBD, his/her assets
remaining in the qualified plan must be distributed at least as rapidly as under the
METHOD of distribution being used to satisfy the MRD rules on the date of the
participant’s death. [§401(a)(9)(B)(i)] The final regulations published on April 17, 2002
significantly modify the Service’s previous interpretation of the “at least as
rapidly” rule that was explained in the original proposed regulations published in
1987. [§1.401(a)(9)-2, A-5] The postmortem provisions of the final regulations
appear in flow chart format on Tables 25A
and 25B of this document. The financial implications of those rules are
illustrated on Tables 27A through 29C.
What
Is The Minimum Annual Distribution During Your Lifetime? Please
remember that a minimum required distribution is exactly what the title states. It is only a minimum. [§1.401(a)(9)-5, A-1(a)] Taxpayers are free to withdraw a greater amount anytime they
wish. Regrettably, any excess taken out one
year may not be used to offset a portion of the required amount in a future year. [§1.401(a)(9)-5, A-2] Roth IRA owners need not make required
distributions during their lifetime. [§401A(c)(5)(A)] A.
Calculating
minimum required distributions during a participant’s lifetime is relatively
straightforward. The process is represented
by the following mathematical equation. MRD200X = Account Balance At
End of Preceding Year ¸ Applicable
Distribution Period 1.
With one rather unique exception outlined immediately below, the Applicable
Distribution Period used in the formula for each year, including the year of the
participant’s death, is the factor shown on the Uniform Lifetime Table shown in
§1.401(a)(9)-9, A-2 that corresponds to the participant’s age as of that
person’s birthday in the relevant distribution calendar year. 2.
In the event the sole Designated Beneficiary of a participant is his or her spouse,
the applicable distribution period might be longer. It
depends on the age spread between the spouses. The
participant may use the longer of the factor derived from the table mentioned in the
preceding paragraph or the joint life expectancy of the spouses shown on the Joint and Last Survivor Table in
§1.401(a)(9)-9, A-3 based on their attained ages as of their respective birthdays in the
distribution calendar year. Anytime the sole
DB is a non-participant spouse born more than ten calendar years after the
participant’s year of birth, the couple’s joint life expectancy will be longer
than the factor from the Uniform
Lifetime Table. [§1.401(a)(9)-5, A-4(b)]
3.
Table 21A of this document entitled
“Calculating Minimum Required Distributions During Participant’s Lifetime”
provides an example of the calculation process. Also
attached is Table 21B listing
all the distribution periods from the Uniform Lifetime Table. B.
Keep in mind that aggregation rules are available for required distributions from
multiple IRA’s and §403(b) Tax Sheltered Annuities.
Unfortunately, pension, profit sharing and stock bonus plans are NOT eligible for
this benefit. Revenue Notice 88-38] 1.
This means that a taxpayer with three IRA’s could pull the sum of the
MRD’s individually computed for each of the three accounts entirely from the lowest
yielding IRA rather than pro rata from all three. The
same would be true if the client had a trio of TSA’s.
Please note, however, that the final regulations modify Revenue Notice 88-38
by disallowing withdrawals taken out of an inherited IRA or TSA from satisfying required
distributions a person must remove from his or her own IRA or TSA. Although distributions to a beneficiary of the
same decedent may be aggregated, such amounts may not be used to satisfy minimum
withdrawals to the same beneficiary from IRA’s or TSA’s of other decedents. [§1.408-8, A-9 and
§1.403(b)-3, A-4] 2. It is not permissible to take IRA minimum required distributions from a low yielding TSA or vice versa. Furthermore, withdrawals from a Roth IRA will not satisfy the distribution requirements applicable to Traditional IRA’s or §403(b) accounts. In addition, assets removed from those accounts cannot be used to fulfill the postmortem MRD’s from Roth IRA’s.
Technical
Terms And Concepts You Need To Understand While
the final regulations issued by the Service in April of 2002 are a lot less complex than
the original ones published in 1987, they do not fall under the heading “tax
simplification”. The 2002 Rules of the Road still require travelers to
know the definition of a few important terms and have a working knowledge of several
interdependent concepts before leaving home for a trip across town. A.
Required Beginning
Date (RBD): All IRA owners as well as participants in
qualified plans that own more than five percent
of the sponsoring employer must begin distributions no later than April 1 of the year
following the year in which the participant attains age 70˝. The RBD for all other employees and §403(b) plan
participants is April 1 of the calendar year following the later of either: (1) the calendar year in which the employee
attains age 70˝, or (2) the calendar year in which the employee retires from employment
with the employer maintaining the plan. [§401(a)(9)(C)] Note, however, that under §1.401(a)(9)-2, A-2(e)
a plan may elect to use the RBD rules
mandated for IRA’s for all employees, i.e., April 1 of the year following the
year the employee attains age 70˝. Therefore,
it is necessary to determine if such an election has been made for the plan in question
before it is possible to be certain about the Required Beginning Date for its
participants. It is also important to keep
in mind that the special rule for extending the RBD only applies to qualified plans and
§403(b) plans maintained by the participant’s current employer. The RBD rules for all plans associated with a
former employer are the same as for IRA’s. B.
Distribution
Calendar Year (DCY): A calendar year for which a minimum distribution
is required is a distribution calendar year. For
example, the calendar year in which an IRA owner attains age 70˝ is his or her first DCY,
even though the actual withdrawal may take place during the first quarter of the following
year. The year containing his or her required
beginning date is that person’s second distribution calendar year. The first DCY for a beneficiary occurs in the
calendar year during which he or she must take the first distribution from the inherited
account. [§1.401(a)(9)-5, A-1(b)] C.
Account Balance: The benefit used in determining the minimum
required distribution for a distribution calendar year is the market value of the account
as of the last valuation date in the calendar year immediately preceding that DCY. Although the valuation date may vary from one
qualified plan to another, the final regulations specify that it must fall on December 31
for IRA’s and §403(b) plans. The
account balance used to calculate MRD’s for the second DCY is not adjusted when a participant delays
taking the minimum withdrawal for his or her first distribution calendar year until the
first quarter of the following year. This
differs from the 1987 and 2001 proposed regulations which stipulate that the account
balance used for computing the required distribution for the second DCY is the market
value at the end of the preceding year less the minimum distribution that was delayed. [§1.401(a)(9)-5, A-3 and
§1.408-8, A-6] D.
Applicable
Distribution Period (ADP): This is the divisor in the mathematical equation
used to compute the required distribution for a given distribution calendar year. For distributions during a participant’s
lifetime, including the year of his or her death, the ADP is obtained in the manner
described in item “A” of the section above entitled “What Is The Minimum Annual Distribution During
Your Lifetime?” and illustrated on Table 21A. The ADP used for computing distributions following
the year of a participant’s death is derived from the Single Life Table in §1.401(a)(9)-9, A-1. Postmortem MRD’s are calculated in
accordance with §401(a)(9)(B) of the Internal Revenue Code as well as §1.401(a)(9)-5,
A-5(a) and (b) of the final regulations. (See the
flow charts on Tables 22, 25A and 25B for
a detailed explanation of postmortem distributions.) E.
Designated
Beneficiary (DB): A Designated Beneficiary is an individual who is
entitled to receive a portion of the benefits of a qualified plan following the death of
the participant or another specified event. It
is important to note that it is possible to name a beneficiary for a qualified plan but NOT have a “Designated
Beneficiary”. (See item “J” below for examples.) Please refer to item
“G” below for a discussion of how to identify a DB when a trust serves as
beneficiary. Readers should also become
familiar with the comments in item
“L” below that deal with the necessity to redetermine the identify of an
account’s DB’s if the participant died before 2003. 1.
The “designation” must be spelled out in the plan itself or with an
affirmative election by the plan participant. [§1.401(a)(9)-4,
A-1 and A-2] a)
It is not valid if merely stipulated under state law. b)
It is not valid to simply use a joint and last survivor annuity settlement without also
naming a beneficiary. 2. The Internal Revenue Code only allows a Designated Beneficiary to be an individual or group of individuals. However, see item “G” below for circumstances in which DB status is achieved if a trust serves as beneficiary. [§.401(a)(9)(E)] a)
The individual must be identifiable under the plan as of the participant’s
date of death and remain a beneficiary as of September 30 of the calendar year following
the year of the participant’s death – the Designation
Date. (See item
“F” below.) [§1.401(a)(9)-4,
A-4(a)] b)
Members of a class of beneficiaries capable of expansion or contraction will be
treated as being identifiable if it is possible, as of the date the designated beneficiary
is determined, to identify the class member with the shortest life expectancy. [§1.401(a)(9)-4, A-1] c)
An individual who is a beneficiary as of the date of the participant’s death
and dies prior to September 30 of the year following the year of the participant’s
death without disclaiming, continues to be treated as a beneficiary on the Designation
Date for purposes of identifying the DB, regardless of the identity of the successor
beneficiary who is entitled to distributions as the beneficiary of the deceased
beneficiary. [§1.401(a)(9)-4, A-4(c)] 3.
Under the final regulations, a Designated Beneficiary must be a beneficiary as of
the participant’s date of death and remain a beneficiary on the Designation Date. Consequently, any person who is a beneficiary as
of the date of the participant’s death, but is not
a beneficiary on September 30 of the following year, is ignored. [§1.401(a)(9)-4, A-4(a)] That same citation in the final regulations
mentions two circumstances in which a beneficiary on the participant’s date of death
would not be considered a beneficiary as of Designation Date. a)
If a beneficiary executes a qualified disclaimer under I.R.C. §2518 by the
Designation Date, that person will not be taken into account in determining the
participant’s Designated Beneficiaries. When reading this provision please remember that unless
a participant actually died on December 31, the deadline for making a qualified
disclaimer differs from the September 30 Designation Date. b)
If a beneficiary receives the entire benefit to which he or she is entitled before
September 30 of the year following the year in which the participant died, that person or
entity will not be considered a beneficiary for designated beneficiary purposes. F.
Designation
Date: The designation date is
September 30 of the year immediately following the year of a participant’s death. This is the date of record used when determining
if an account has one or more Designated Beneficiaries.
See paragraph 3 in item “E” above for more
details. Please note that this term is the
author’s own creation. It does not
appear in the Code or Regulations. G.
Trust As Beneficiary: Under certain circumstances specified in the final
regulations, DB status can be achieved if a trust is named as beneficiary. Please note that the trust itself is not the
Designated Beneficiary since only an individual human being may be a DB. However, the beneficiaries of the trust will
qualify as DB’s if the trust meets certain requirements. [§1.401(a)(9)-4, A-5(a)] Table 23
lists a summary of those requirements that are spelled out in detail below. 1.
A Designated Beneficiary can exist when a trust is the qualified plan’s
beneficiary provided four requisites are met. [§1.401(a)(9)-4, A-5(b)] a)
The
trust is valid under state law, or would be but for the fact that there is no
corpus. b)
The
trust is irrevocable or will, by its terms, become irrevocable upon the death of the
participant. c)
The trust’s own beneficiaries who will be receiving proceeds from the
qualified plan are named individuals or identifiable from the trust instrument, e.g., a
class of beneficiaries such as spouse, children, etc. is acceptable. The members of a class of beneficiaries capable
of expansion or contraction will be treated as identifiable if it is possible to identify
the class member with the shortest life expectancy. d)
Certain
documentation is provided to the plan administrator so that the beneficiaries of the trust
who are beneficiaries with respect to the trust’s interest in the participant’s
benefit are identifiable to the plan administrator. Please
note that for purposes of all the documentation rules outlined herein, an IRA trustee,
custodian or issuer is treated as the plan administrator.
[§1.408-8, A-1(b)] The
trustees, custodians and issuers of TSA contracts under §403(b) are also treated as the
plan administrator. [§1.403(b)-3, A-1(b)] 2.
For purposes of required distributions during the participant’s lifetime,
it is only necessary to fulfill all four of the requisites if the sole designated beneficiary is the
participant’s spouse and that DB was born more than ten calendar years after
the year of the participant’s birth. It
should be noted that no deadline exists for satisfying those four conditions in order to
qualify for the Younger Spouse Rule. Until
all four are met, however, the participant must use the less advantageous ADP’s from
the Uniform Lifetime Table. Therefore, it is
prudent to fulfill the four requirements not later than the date on which the trust
becomes a beneficiary of the qualified plan or
the participant’s RBD – as well as during all subsequent periods in which the
trust serves as a beneficiary. [§1.401(a)(9)-4,
A-6(a)] a)
The participant provides a copy of the trust instrument to the plan administrator
and agrees that if the trust instrument is amended at any time in the future, he/she will,
within a reasonable time, provide to the plan administrator a copy of each such amendment. b)
The participant provides the plan administrator with a list of all the
beneficiaries of the trust (including contingent and remainder beneficiaries) along with a
description of the conditions for their entitlement.
He or she must certify that, to the best of his/her knowledge, the list is correct
and complete and that the requirements of 1 a), b), c) and d) above are satisfied. In addition, the plan participant must agree to
provide corrected certifications if an amendment changes any information previously
certified. Finally, the participant agrees to
provide a copy of the trust instrument to the plan administrator upon demand. 3.
For purposes of required distributions following a participant’s death,
items a) and b) in item 1 above must be satisfied as of the date of death. Requirement c) must also be fulfilled on September
30 of the year following the year of the participant’s death. Requisite d) in item 1 above must be completed by
October 31 of the year immediately following the year the participant dies. Taking either of the following steps can satisfy
the postmortem documentation requirement. [§1.401(a)(9)-4,
A-6(b)] a)
The trustee provides the plan administrator with a copy of the actual trust
document for the trust that is named as a beneficiary of the participant under the
qualified plan as of the date of death. b)
The trustee provides the plan administrator with a final list of all the
beneficiaries of the trust as of October 31 of the year following the year the participant
died (including contingent and remainder beneficiaries) along with a description of the
conditions for their entitlement. The trustee
must certify that, to the best of the trustee’s knowledge, the list is correct and
complete and that the requirements of 1 a), b) and c) above are satisfied. In addition, the trustee agrees to provide a copy
of the trust instrument to the plan administrator upon demand. 4. Payments to a trust from a qualified plan after the participant’s death need not be distributed to the trust’s own beneficiaries. That is to say, such payments may be retained inside the trust for distribution to its beneficiaries at anytime in the future. [§1.401(a)(9)-8, A-11] H.
Calculation-DB: If a group of individuals are DB’s, the
person with the shortest life expectancy will be the Designated Beneficiary for purposes
of selecting the life expectancy factor to use in MRD calculations. [§1.401(a)(9)-5, A-7(a)(1)] This person is sometimes referred to as the
“calculation-DB” although that term does not appear in the Code or Regulations.
1.
In the event one or more of the beneficiaries of an account as of September 30 of
the year following the year the participant dies does not qualify as a Designated
Beneficiary, the participant will be treated as not
having any DB’s. This is true
even if the other beneficiaries are individuals that fulfill the DB requirements. NOTE: This
rule applies regardless of when death occurs. [§1.401(a)(9)-4,
A-3] 2.
The existence of a contingent beneficiary usually has no bearing on determining the
individual DB with the shortest life expectancy or whether there is a beneficiary
that does not qualify as a DB. However, a
contingent will be treated as a primary
beneficiary for either purpose if that contingent beneficiary is entitled to receive a
portion of the participant’s benefit beyond being a mere potential successor to the
interest of one of the participant’s primary beneficiaries upon that
beneficiary’s death. Here is the example
that illustrates this point in §1.401(a)(9)-5, A-7(c)(1).
“If the first beneficiary has a right to all income with respect to an
employee’s individual account during that beneficiary’s life and a second
beneficiary has a right to the principal but only after the death of the first income
beneficiary (any portion of the principal distributed during the life of the first income
beneficiary to be held in trust until that first beneficiary's death), both beneficiaries
must be taken into account in determining the beneficiary with the shortest life
expectancy and whether only individuals are beneficiaries.” I.
Separate Accounts:
The separate account rule is so technical that it is necessary to begin a
discussion of the subject by providing the following direct quote from
§1.401(a)(9)-8, A-3(a) of the final regulations.
“For purposes of §401(a)(9), separate accounts in an employee’s
account are separate portions of an employee’s benefit reflecting the separate
interests of the employee’s beneficiaries under the plan as of the date of the
employee’s death for which separate accounting is maintained. The separate accounting must allocate all
post-death investment gains and losses, contributions, and forfeitures, for the period
prior to the establishment of the separate accounts on a pro rata basis in a reasonable
and consistent manner among the separate accounts. However,
once the separate accounts are actually established, the separate accounting can provide
for separate investments for each separate account under which gains and losses from the
investment of the account are only allocated to that account or investment gain or losses
can continue to be allocated among the separate accounts on a pro rata basis. A separate accounting must allocate any post-death
distribution to the separate account of the beneficiary receiving that distribution.” Separate accounts with different beneficiaries
under the plan can be established at any time, either before or after the
participant’s RBD. However, separate
accounts for beneficiaries entitled to a fractional or percentage
interest must be established before December 31 of the year following the year of the
participant's death in order to isolate non-DB's from individual beneficiaries, thus
allowing the latter to enhance their stretch-out potential. By subdividing a single
account into separate shares (accounts) by the end of the year following the year of the
participant's death, it is also permissible to use the life expectancy of the oldest
beneficiary of each respective share when determining the distribution period for that
separate account. Therefore, a Designated
Beneficiary (with a short life expectancy) on one separate account within a qualified plan
can be ignored when determining the calculation-DB on another separate account. (If you truly understand this entire paragraph,
please submit your résumé to the IRS – they have just the job for you.) J.
Non-DB Status: Naming a charity,
partnership, corporation or an estate as a partial or total beneficiary of a separate account within a
qualified plan means that at least a portion of the assets will pass to a non-human
entity. If one of the beneficiaries for a
separate account is such an entity, that separate account will be treated as not having a
Designated Beneficiary even though the other beneficiaries are humans. [§1.401(a)(9)-4, A-3] K.
Spousal Rollover IRA: There are three methods by which a person that is
a beneficiary of his or her deceased spouse’s qualified plan or IRA may reposition
those assets into an individual retirement account
and elect to treat the new account as his or her own.
This is true regardless of when the participant dies. Throughout this document, that new account is
referred to as a “Spousal Rollover IRA” – regardless of the steps taken to
create it. 1.
A
surviving spouse beneficiary may create a spousal rollover IRA by simply assuming
ownership of the deceased owner’s individual retirement account. It is important to note that this method is only
available with IRA’s, not other forms of qualified retirement plans. Furthermore, the surviving spouse must be the sole
Designated Beneficiary of the entire account or a separate share and have the unlimited
right to withdraw amounts from the IRA. a)
If an election is made to treat the account as the surviving spouse's own during the IRA owner’s year of death, the surviving spouse
beneficiary may NOT assume ownership of the portion of the decedent’s account equal
to the MRD for the current year that somehow failed to be distributed to the participant
before death. [§1.408-8, A-5(a)] Instead, the spouse must withdraw the previously
undistributed amount of the MRD and recognize its taxable portion on that year’s
income tax return. b)
In the event the surviving spouse elects to treat the account as his or her own in
any year following the year of the IRA owner’s death, the surviving
spouse beneficiary is allowed to retitle the entire account or separate share –
including the MRD, if any, for the current year that would otherwise need to be taken as
beneficiary. No aspect of the ownership
change constitutes a taxable event. Please
note, however, that under this scenario, the account is treated as belonging to the
survivor as of December 31 of the preceding year.
Therefore, the lifetime required distribution rules apply for the year of the
ownership change based on the attained age of the surviving spouse. [§1.408-8, A-5(a)] 2.
A surviving spouse beneficiary may create a spousal rollover IRA under §402(c)(9)
by rolling over assets distributed to him or her from a qualified retirement plan such as
a pension, profit sharing or stock bonus plan.
Provided the surviving spouse subsequently elects to treat the IRA as his or her own, the
tax ramifications are identical to the explanation found in paragraph 3 immediately
below. [§1.408-8, A-7] Please note, however, that a surviving spouse
need not elect to treat the IRA as his or her own following the rollover of assets from a
deceased participant's pension, profit sharing or stock bonus plan. In such a case,
the surviving spouse remains the beneficiary of the Individual Retirement Account without
assuming ownership. Hence, the IRA remains a beneficiary distribution account
instead of becoming a spousal rollover IRA and required distributions must be determined
under the postmortem guidelines when a spouse is beneficiary. 3.
It is also possible to create a spousal rollover IRA when a surviving spouse is not
the sole beneficiary of a deceased IRA owner’s account. To do so,
the survivor transfers the portion of the account to which he or she is entitled into an
individual retirement account in the survivor’s own name. By following this
strategy, the applicable tax treatment differs slightly from the procedures discussed in
paragraph 1 of this section K. Regardless of
the year of the rollover, the surviving spouse beneficiary must treat withdrawals from the
decedent’s IRA as first fulfilling the current year’s required distribution to
him/herself as beneficiary. Therefore,
any portion of the year’s required distribution not yet removed from the old account
may NOT be rolled over into the spousal rollover IRA.
Thus, a surviving spouse must first remove sufficient funds from the decedent's
account to satisfy the current year's MRD to him/herself as beneficiary (and recognize
that amount as taxable income) before rolling over the balance. Because the survivor is the owner of the
spousal rollover IRA, the account is subject to the lifetime required distribution rules
based on the owner's attained age each year beginning in the year following the year of
the rollover. [§402(c)(9) and §1.408-8,
A-7] L.
Redesignation/Reconstruction
Rule: The final regulations state
that required distributions apply to account balances and benefits held for beneficiaries
for calendar years beginning on or after January 1, 2003.
This is true even if the participant died prior to the start of 2003. Therefore, in every case of a participant that died before
January 1, 2003, the DB must be redetermined in
accordance with the provisions of the final regulations and the applicable
distribution period must be reconstructed using
those same regulations when it is time to compute MRD’s for distribution years 2003
and later. Please note that this rule cannot
alter the recipients of the benefits, but it may well change the level of those
distributions because the calculation-DB under the final regulations could differ from the
person whose life expectancy is used for calculation purposes under the 2001 or 1987
proposed regulations. [§1.401(a)(9)-1,
A-2(b)(1)] A.
When
a participant DIES BEFORE THE REQUIRED
BEGINNING DATE, the applicability of the five-year rule and its two exceptions depends
as much on the plan’s language as it does on the wishes of the beneficiary. (See the flow chart on Table 24 entitled “Plan Restrictions Control
Postmortem Distribution Options Before The Required Beginning Date”) Please note that a qualified plan is allowed to
effectively eliminate all the postmortem options available under the tax rules by
requiring a complete distribution at some point before the deadline imposed by the
Five-Year Rule. This could be a major blow to
postmortem planning by the survivors unless a trustee-to-trustee transfer can be used to
reposition the assets to a plan with more liberal provisions. 1.
If the plan does not include a provision describing the method of
distribution after the death of a participant, the final regulations specify that
distributions MUST conform to the following rules. a) In cases where there is a Designated Beneficiary, distributions are to be made in accordance with either the “General Exception” or the “Spousal Exception” to the Five-Year Rule. [§1.401(a)(9)-3, A-4(a)(1)] b)
All other cases must adhere to the Five-Year Rule.
[§1.401(a)(9)-3, A-4(a)(2)] 2.
Under the final regulations, a qualified plan may adopt provisions specifying how
distributions will be carried out if the participant dies before his/her required
beginning date. For example, a plan is
allowed to establish one method for a surviving spouse and another for non-spouse
beneficiaries. However, there must be a
single method covering the distribution of all benefits in each separate account belonging
to a participant. Note also that the plan
rules may be more restrictive than the tax law. [§1.401(a)(9)-3,
A-4(b)] a)
Every beneficiary could be forced to withdraw under the provisions of the Five-Year
Rule or before an earlier date. b)
A Surviving spouse might be allowed to use the General Exception or Spousal
Exception while all others would be restricted to the Five-Year Rule or an earlier
withdrawal deadline. c)
Non-spouse beneficiaries might be permitted to use the General Exception but a
spouse would be limited to the Five-Year Rule or an earlier withdrawal deadline. d)
All
beneficiaries could be required to use either the General Exception or the Spousal
Exception depending on their relationship with the deceased participant. NOTE: This
does not present a problem because a beneficiary may always accelerate withdrawals
if he/she wants to rapidly drain the account. 3.
The plan may allow an election by the participant or their beneficiaries. If such an election is possible, the plan may
specify which method of distribution applies if neither the participant nor the
beneficiary makes that election. In the event
neither party elects a method and the plan fails to stipulate which rule applies,
the proposed regulations state that distributions must be made as if the plan contained no
option provisions (see #1 above). [§1.401(a)(9)-3,
A-4(c)] a)
The election must be made by the earlier of: (1)
December
31 of the calendar year in which distribution would be required to commence to satisfy the
two exceptions to the Five-Year Rule, or (2)
December
31 of the calendar year that contains the fifth anniversary of the participant’s
death. b)
As of such date, the election must be irrevocable with respect to the
beneficiary and all subsequent beneficiaries. c)
The election must apply to all subsequent years. 4.
The final regulations provide a transition rule that will allow certain Designated
Beneficiaries of participants that died before their Required Beginning Date to use the
General Exception, even though the beneficiary failed to take the MRD’s starting in
the year following the year of the participant’s death. [§1.401(a)(9)-1, A-2(b)(2)] A thorough explanation of this point is available
in Planning
Pointer “S”. B.
When a participant DIES ON OR AFTER
THE REQUIRED BEGINNING DATE, the “... at least as rapidly ...” phrase in IRC
§401(a)(9)(B)(i)(II) leaves plenty of latitude for qualified plans to foil distribution
planning. For example, it is not uncommon to
run across corporate-sponsored retirement plans that force non-spouse beneficiaries to
make a 100% withdrawal as soon as reasonably possible.
Fortunately, IRA’s and TSA’s seldom have such draconian
provisions. [Remember, IRC §401(a)(9)(B)(i)(II) does NOT apply to
Roth IRA’s because no method is used to compute required distributions before the
owner’s death.] 1.
Although having plan provisions that are more restrictive than the tax rules may
appear to place a firm at a competitive disadvantage, corporate-sponsored retirement plans
often use them to protect the plan from failing to make minimum required distributions
and, hence, fall out of compliance. In a
majority of instances, the offending provisions are so deeply imbedded in the plan’s
disclosure documents that innocent participants hardly ever stumble onto them. Even knowledgeable practitioners can overlook
these minute snags. It is possible that the
more streamlined rules under the final regulations may bring forth a positive change, but
the author has serious reservations that plan administrators will ever want to shoulder
responsibility for fulfilling required distributions over fifty or sixty years to a
participant’s grandchild. 2.
On a more positive note, IRA’s and §403(b) plans are usually quick to
incorporate all the stretch-out provisions of the tax rules in order to encourage the
retention of assets. In many cases, the final
regulations allow longer tax-deferred accumulation by beneficiaries than under the
original 1987 rules or even the 2001 proposed regulations.
Do not be surprised if you soon hear IRA and §403(b) providers trumpeting the
elongated stretch-out aspects of the final regulations.
While it is true that the final regulations do impose an additional reporting
requirement on IRA providers beginning in 2003, the extra burden will not be a deterrent. By the way, those reports will only be necessary
during the lifetime of an IRA owner. Beneficiary
distribution accounts are exempt. 3.
The intertwining alternatives that deal with minimum required distributions
following a participant’s post-RBD death seem to outnumber the freeways in Los
Angeles. If not, they certainly match the
twists and turns of the latter. Rather than
attempt to describe those intricacies in outline format, it is far more effective for
readers to view them on flow charts. Those
charts, located on Tables 25A and 25B, provide a map that will help beneficiaries
navigate though the maze. To effectively use
the tables you must first know if the sole Designated Beneficiary is the
participant’s spouse. If so, turn to Table 25A.
In all other cases, begin by perusing Table
25B. The black tab near the top left
corner of each table will also help guide you to the proper one. Once on the correct table, start at the oval
identifying the facts and circumstances that match your case and then follow the arrows. C. Corporate-sponsored retirement plans will soon amend their provisions to comply with the final regulations. No doubt, IRA and §403(b) plan providers will follow suit. Hopefully, all of them will embrace the generous latitude provided for DISTRIBUTIONS DURING A PARTICIPANT’S LIFETIME. However, §1.401(a)(9)-1, A-3(b) does allow those plans to be more restrictive. An explanation of the final regulations dealing with lifetime distributions can be found earlier in this document under a heading "What Is The Minimum Annual Distribution During Your Lifetime?" The application of those steps is illustrated on Table 21A. [Note: IRC §408A(c)(5)(A) exempts Roth IRA’s from required distributions during the owner’s lifetime.] The text on the preceding pages provides a reasonable primer to use when beginning to explore the financial and estate planning implications of the minimum distribution rules under IRC §401(a)(9) and the final regulations published by the Internal Revenue Service on April 17, 2002. The 2002 Planning Pointers listed on another page of this web site provide important reminders to individual participants, their beneficiaries and planning professionals. Further insights will soon be available on another page of this web site entitled “2002 Practical Considerations”. Once posted, that page will furnish a detailed explanation of Tables 26 through 29C. Other Resources Practitioners looking for software are encouraged to contact Net Worth Strategies in Bend, Oregon. The firm’s web site is www.networthstrategies.com. Their excellent MRD Determinator™ program was created by a good friend, Guerdon T. Ely, CFP™. The extremely comprehensive and user-friendly input wizard built into MRD Determinator™ produces accurate required distributions amounts under any set of circumstances. Included too are text explanations along with detailed descriptions and applicable citations. Another vendor worth considering is Brentmark Software. Their telephone in Winter Park, Florida is (800) 879-6665. The company’s web site is www.brentmark.com. Ask Brentmark to send you a free demonstration disk for the “Pension & Roth IRA Analyzer” as well as their “Minimum Distributions Calculator.” Those programs offer a viable means to deal with many routine situations. Unfortunately, they do not provide sufficient flexibility to conduct advanced planning unless the user is willing to enter an enormous amount of hand-calculated data. If you have read to this point in the text, be sure to peruse the 2002 Planning Pointers on another page of this web site. They apply the Rules of the Road spelled out above to everyday circumstances confronting both individual participants and planning professionals.
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