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© George H. Coughlin II 2002 All Rights Reserved Return to Home Page |
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New Minimum Distribution Rules: Less Quicksand,
More Terra Firma and Greater Stretch-Out Potential Most taxpayers
mistakenly believe that the required distribution rules spelled out in §401(a)(9) of the
Internal Revenue Code only apply to lifetime distributions beginning at age 70½ from
their qualified retirement plans, Individual Retirement Accounts and Tax Sheltered
Annuities [§403(b) plans]. Failure to consider the numerous financial and estate planning
implications of those tax provisions can lead to unpleasant complications during
retirement and/or substantial financial loss for survivors. Everyone with assets in a
retirement plan, regardless of their age, needs to have a reasonable understanding
of minimum required distributions. In certain circumstances, that understanding can be
more valuable than the selection of a prudent investment. Unfortunately,
the complexity associated with this area of the tax law intimidates many taxpayers. If you
readily identify with that group, rest assured you have plenty of company. Even competent
tax practitioners often miss the financial and estate planning implications associated
with required distributions although they understand how to apply those rules when
preparing a tax return. The
following questions provide a quick way to gauge your knowledge of this subject.
The “New Rules of the Road” and “New Planning Pointers” that follow this introduction provide technical assistance for those wishing to improve their understanding or research a specific question. Please note, however, that this document should not be used as a substitute for the knowledge and insights available from a well-trained professional who routinely deals with these issues. Readers who undertake their own planning are urged to double-check their conclusions by obtaining a professional opinion before implementing those plans. In addition, please peruse the following disclaimer. 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 in this handout does NOT involve George Coughlin or his broker/dealer ePLANNING Securities, Inc. Please use appropriate caution.
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.
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. When Do The New 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 70½. 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 70½. That date is referred to as their Required Beginning Date or RBD. [§401(a)(9)(C)] See page 6 for a complete definition of “RBD” -- including an exception for certain participants as well as a 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 70½, 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 71½. 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 71½. [§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 70½. (For more details, please refer to the discussion on page 6 entitled “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. 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)-2, 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 new guidelines closely parallel the provisions of the old proposed regulations. It should be noted, however, that the default method in the new proposed regulations is the life expectancy rule, referred to below as the General and Spousal Exceptions. In the past, the Five-Year Rule served as the default. Under certain circumstances that subtle shift can have a favorable impact on beneficiaries. See item "S" in the Assorted Planning Pointers for more details.
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 review the definition of that term as
well as the discussion of "separate accounts" that appear later in this document
under the heading "Technical Terms and
Concepts You Need To Understand.") 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 a qualified plan is broken into
separate accounts with a different beneficiary for each, 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)] 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 appears 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 new proposed regulations released on January 11, 2001 significantly modify the Service’s previous interpretation of the “at least as rapidly” rule as explained in the old proposed regulations published in 1987. [§1.401(a)(9)-2, A-5] The new provisions 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.
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 determined using the uniform table shown in §1.401(a)(9)-5, A-4(a)(2)(i) for 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 sentence or the joint life expectancy of the spouses derived from Table VI of §1.72–9 using their attained ages as of their respective birthdays in the distribution calendar year. Anytime the sole DB is the non-participant spouse born more than ten calendar years after the participant’s year of birth, their joint life expectancy from Table VI will be the longer factor. [§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 distributions periods from the uniform table. The Joint Life Expectancy Table VI can be found in Income Tax Regulation §1.72–9 as well as Appendix “E” of IRS Publication 590 under the heading “Table II (Joint Life and Last Survivor Expectancy)”. B. Keep in mind that aggregation rules are available for required distributions from multiple IRA’s and 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 new proposed 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)-2, A-4] 2. It is not permissible to take IRA minimum required distributions from a low yielding TSA or vice versa.
While the new proposed regulations issued by the Service on January 11, 2001 are a lot less complex than the original ones published in 1987, they do not fall under the heading “tax simplification”. The New 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 70½. 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 70½, or (2) the calendar year in which the employee retires. [§401(a)(9)(C)] Note, however, that under Revenue Notice 97-75 a plan may elect to use the RBD rules mandated for IRA’s, i.e., April 1 of the year following the year the employee attains age 70½. 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 70½ 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 their 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. An account balance is adjusted whenever a participant delays taking the minimum withdrawal for his or her first distribution calendar year until the first quarter of the following year. Under those circumstances 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 Table V of Reg. §1.72-9 in accordance §401(a)(9)(B) of the Internal Revenue Code as well as §1.401(a)(9)-5, A-5(a) and (b) of the new proposed regulations. 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. (See item "G" below when a trust serves as beneficiary.) Please 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.) 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 date the designated beneficiary is determined under A-4 of §1.401(a)(9)-4. 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. 3. Under the proposed regulations released on January 11, 2001 Designated Beneficiaries are determined based on the account’s beneficiaries as of the last day of the calendar year following the calendar year of the participant’s death – the “designation date”. (See item “F” below.) Consequently, any person who was a beneficiary as of the date of the participant’s death, but is not a beneficiary as of the end of the following year, is not taken into account. [§1.401(a)(9)-4, A-4] That same citation in the new proposed regulations also mentioned two circumstances in which a beneficiary on the participant’s date of death would not be considered a beneficiary as of December 31 of the following year. a) If a person disclaims entitlement to the benefit he or she would otherwise receive as beneficiary, that person will not be considered a beneficiary when it comes time to identify designated beneficiaries. b) If a beneficiary receives the entire benefit to which he or she is entitled before December 31 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 December 31 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 new proposed regulations issued on January 11, 2001 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 prerequisites 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. 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)-2(b)] Taking either of the following steps can satisfy the documentation requirement. [§1.401(a)(9)-4, A-6(a)] (1) 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. (2) 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. 2. For purposes of required distributions during the participant’s lifetime, it is only necessary to fulfill all four of the prerequisites 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 birth. Under those circumstances the prerequisites must be met not later than the date on which the trust is named as a beneficiary of the participant or the participant’s RBD and all subsequent periods during which the trust is named as a beneficiary. [§1.401(a)(9)-4, A-6(a)] 3. For purposes of required distributions following a participant’s death, prerequisites a) and b) in item 1 above must be satisfied as of the date of death. Prerequisites c) and d) in item 1 above must be satisfied by December 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 the end 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 December 31 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)-5, A-7(a)(1)] 2. The existence of a contingent beneficiary will have 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 purposes of determining the DB if that contingent beneficiary is entitled to receive a portion of the plan’s benefit because a primary beneficiary died after the participant’s death but before December 31 of the following year. [§1.401(a)(9)-5, A-7(c)(1)] I. Separate Accounts: For purposes of §401(a)(9), a separate account is a portion of a participant’s benefit in a qualified plan determined by an acceptable separate accounting. That accounting includes allocating investment gains and losses, and contributions and forfeitures, on a pro rata basis in a reasonable and consistent manner between such portion and any other benefits. Furthermore, the amounts of each such portion of the benefit will be separately determined for purposes of computing the amount of the minimum required distribution. [§1.401(a)(9)-8, A-3(a)] This means, for example, that it is possible to have non-DB status on one separate account without impacting the DB status of another separate account within the same qualified plan. Similarly, 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. While the new proposed regulations released on January 11, 2001 offer greater clarification on this point than those published in 1987, this author truly hopes that the public hearing on June 1 will prompt the Service to clearly state that separate accounts may be created following the death of a participant that dies on or after their RBD. Until then, the feasibility of such activity remains in question. Nevertheless, the following options are allowed under the new rules. 1. If the participant dies BEFORE his or her required beginning date, separate accounts may be established postmortem. Provided they are established by December 31 of the year immediately following the participant’s year of death, it is permissible to treat the beneficiaries of each account independently when identifying the DB and computing distributions to the survivors. [§1.401(a)(9)-8, A-2(b)] 2.
If separate accounts are established within the qualified plan by the required
beginning date, or by the beginning of any distribution calendar year beginning after the
employee’s RBD, a participant can treat the beneficiaries of each account
independently when computing lifetime distributions.
Following the participant's death, the DB status of each separate account is
determined without regard to the beneficiaries of the other separate accounts. [§1.401(a)(9)-8, A-2(b)] 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 there are beneficiaries for an account other than human beings, the account will be treated as not having a designated beneficiary. [§1.401(a)(9)-4, A-3] K.
Spousal Rollover IRA: A person that is a beneficiary of his or her
deceased spouse’s qualified plan or IRA may roll over a distribution from such a plan
into an individual retirement account and treat the new account as his or her own. The amount transferred is not includible in gross
income for the taxable year in which the transfer occurs.
[§402(c)(9) and §1.408-8, A-7] This
is true regardless of when the participant dies. However,
required distributions that have not yet been removed from the old account may NOT be
rolled over into the spousal rollover IRA. [§1.408-8,
A-4] Once the assets are in the new account,
the survivor becomes the owner of the new IRA. Thereafter,
he or she is eligible to use all the normal distribution options available to an IRA
owner.
All
the distribution planning in the world may be for naught if the plan document blocks the
desired implementation. The tax rules and
regulations previously cited are contingent, in many ways, on the provisions of the
qualified plan. This means that a
participant’s tax and estate planning preferences may not be available through the
current trustee. Of course, a participant or
Designated Beneficiary can execute a trustee-to-trustee transfer between IRA’s and
TSA’s to obtain more flexible distribution options or a wider array of investment
opportunities. Unfortunately, that remedy is
not available if the assets reside in a pension, profit sharing or stock bonus plan. Of course, a surviving spouse named as beneficiary
of any of those plans can work around the problem by using a spousal rollover IRA, but
even that solution may interfere with the estate plan.
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 new proposed 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(c)] b) All other cases must adhere to the Five-Year Rule. [§1.401(a)(9)-3, A-4(c)] 2. Under the new proposed 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. 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 most cases 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 new proposed regulations may bring forth a positive chance, 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 TSA’s usually incorporate all the
stretch-out provisions of the tax rules in order to encourage the retention of assets. Although the new proposed regulations will impose
an additional reporting requirement on IRA custodians and trustees once they become final,
in many cases the provisions allow far longer tax-deferred accumulation by beneficiaries
of participants that die on or after their RBD. Do
not be surprised if you soon hear IRA and TSA providers trumpeting the elongated
stretch-out aspects of the new rules.
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. It is too soon to tell if corporate-sponsored retirement plans will embrace the generous latitude of the new proposed regulations when dealing with REQUIRED DISTRIBUTIONS DURING A PARTICIPANT’S LIFETIME. Certainly, some may decide to be more restrictive. However, pressure from savvy participants may be sufficient to accomplish the task. An explanation of the new tax rules dealing with lifetime distributions can be found on pages 3-5 of this document. 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 new minimum distribution rules under IRC §401(a)(9) and the proposed regulations released by the Internal Revenue Service on January 11, 2001. The New Assorted Planning Pointers listed below provide important reminders to individual participants, their beneficiaries and planning professionals. . In the near future another section will be added to this web page entitled “New Practical Considerations”. Once posted, that page will furnish a detailed explanation of Tables 26 through 29B. Serious students need to go far beyond the limited areas addressed by the author. The new proposed regulations provide a detailed map of the terrain that must be traversed. An excellent interpretation of the minute details on that “map” will be available in the upcoming 4th edition of Life and Death Planning For Retirement Benefits by Natalie B. Choate, Esq. Ms. Choate has a tremendous depth of knowledge in this subject. Her telephone number in Boston is (617) 951-8817. Her web site is www.ataxplan.com. A superb summary of the new proposed regulations is posted on the “What’s New” page of that web site. Another grand master of this subject is Noel C. Ice, Esq. in Fort Worth, Texas. His office telephone number is (817) 877-2885. His web site at www.trustsandestates.net is full of authoritative commentary on this and other subjects. Both Ms. Choate and Mr. Ice provide forms and sample language to assist members of the legal profession. 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 DeterminatorÔ program was created by a good friend, Guerdon T. Ely, CFP. The extremely comprehensive and user-friendly input wizard built into MRD DeterminatorÔ produces accurate required distributions amounts under any set of circumstances. Included too are text explanations along with detailed descriptions and applicable citations. Guerdon has already incorporated the new rules into MRD DeterminatorÔ.
A. Always have a beneficiary designation on file with the plan administrator regardless of the age of the participant. Whenever possible, the named beneficiary should also qualify as a Designated Beneficiary so there will be added stretch-out potential for the postmortem required distributions. This is especially important if a participant dies before the required beginning date. Under those circumstances the absence of a Designated Beneficiary will force a complete distribution of the entire account by the end of the fifth year following the year the participant dies. B. If a non-DB is a beneficiary of an income and/or remainder interest as of December 31 of the year following the participant’s death, NONE of the beneficiaries will be treated as a Designated Beneficiary, even if the rest of the named beneficiaries would otherwise qualify as DB’s. This is true under all circumstances controlled by §401(a)(9). Please remember that each separate account is independent of all others when the time comes to determine its designated beneficiaries. A further explanation of this point appears on page 10 of this manuscript. Also see item “E” below for examples of beneficiaries that do not qualify as DB’s and an explanation of the implications. [§1.401(a)(9)-5, A-7(a) & §11.401(a)(9)-7, A-2(b)] C. When a surviving spouse opens a spousal rollover IRA, be sure to simultaneously select beneficiaries that qualify as Designated Beneficiaries. The reasons parallel those stated in items “A” and “B” above. D. Whenever possible, a secondary and tertiary beneficiary should be named for each account in case the primary beneficiary predeceases the participant. In addition, well-planned contingent beneficiary designations will help facilitate postmortem planning by beneficiaries who might wish to execute disclaimers. (See item "J" for a discussion of valid disclaimers.) E. Extra care should be taken if you are considering using an estate, charity, partnership or corporation as a beneficiary. Those four entities do not qualify as a Designated Beneficiary. (See item “B”.) If a non-DB fails to remove its share of the account prior to the end of the year following the year of the participant’s death, the other beneficiaries will lose valuable stretch-out potential. One sure way to avoid this possible trap is to establish a separate account exclusively for qualified plan assets that will fund gifts to charity. This is important regardless of the participant’s age. (See items “B”, “H” and “P”.) F. Avoid naming members of two generations as joint beneficiaries of the same account. If a large age differential exists among beneficiaries of the same generation, even siblings, split the assets into multiple accounts before the RBD. This will prevent the younger beneficiaries from being penalized by the shorter life expectancy of the oldest beneficiary. Use non-prorated MRD’s each year to keep the various accounts proportionately balanced. Please remember that there is still some doubt about whether it is possible to split a qualified plan into separate shares following a participant’s death after his or her RBD. (See “Separate Accounts" in Technical Terms And Concepts You Need To Understand.) G. Terminally ill participants in corporate qualified plans should seriously consider taking a lump sum distribution so the assets can be rolled over into one or more IRA’s -- especially if there is a non-spouse beneficiary. An IRA will provide the heirs greater flexibility than a pension, profit sharing or stock bonus plan following the participant’s death. Make sure the employee will not lose valuable medical, dental, life and other insurance coverage if it is necessary to separate from service to become eligible for a lump sum distribution. H. The spousal exception to the five-year rule in pre-RBD death cases is prohibited if the spouse is not the sole primary beneficiary of a separate account. Assuming the other beneficiaries qualify as DB’s, the spouse and the other beneficiaries could use the general exception to the five-year rule -- provided it is permitted under the plan provisions. If one or more of the other primary beneficiaries do not meet the DB requirements, ALL beneficiaries must use the five-year rule. (See item “B”.) [§1.401(a)(9)-5, A-7(c)(3), Example 2(iii) and §1.401(a)(9)-8, A-2(b)] I. Letter Ruling 9237038 points out that an EXECUTOR for a surviving spouse that dies before making an election to treat the first deceased spouse’s IRA as his or her own IRA cannot make that election for the deceased surviving spouse. In other words, an executor for the second to die cannot carry out a spousal rollover if the surviving marriage partner fails to do so before his or her own death. Even under the more generous rules of the new proposed regulations, this could result in the loss of valuable tax deferral. Had the rollover to the spousal IRA taken place, the surviving spouse would likely have specified the couple’s children as his or her own beneficiaries. Following the death of the surviving spouse, the beneficiaries of that spousal rollover IRA would be eligible to compute MRD’s using the life expectancy of the oldest DB. Without a spousal rollover there is a reasonable chance that the surviving spouse may have been unable or failed, due to incapacity or procrastination, to name his or her own beneficiaries of the inherited account. In that event there will be no DB when the second spouse dies because his or her estate is likely to be the beneficiary of the inherited account by default. That sequence of events will force the heirs of the estate, most likely the couple’s children, to use the considerably shorter single life expectancy of the second deceased parent when computing required distributions. [§1.401(a)(9)-5, A-5(a)(1)] J. The
new proposed regulations issued on January 11, 2001 clearly establish the Service's
willingness to recognize disclaimers for
purposes of required distributions under IRC §401(a)(9).
[§1.401(a)(9)-4, A-4(a)] Hence,
a primary beneficiary that executes a valid disclaimer by the nine-month deadline
following the participant's death will not be considered a beneficiary when it come time
to determine DB's on the designation date. This technique creates a number of
postmortem planning opportunities. K. If a trust is to be used as a beneficiary for a qualified plan, do so only after a thorough review of the distribution rules and how they interact with the other estate planning needs. Pay special attention to the possibility that a trust may contain language that prevents it from qualifying under the Designated Beneficiary Rules. Finally, be sure to deliver a copy of the trust instrument, or the substitute documentation specified in §1.401(a)(9)-4, A-6 of the new proposed regulations, in a timely manner to the plan administrator. For more details peruse the discussion entitled “Trust As Beneficiary” that appears under the heading Technical Terms And Concepts You Need To Understand. Then be sure to review the language of §1.401(a)(9)-4, A-5 and A-6 in the new proposed regulations. L. If a QTIP trust is to be used as a beneficiary for qualified plans, peruse Rev. Rul. 2000-2. The ruling provides specific guidance to insure that such a trust agreement qualifies for the martial deduction while simultaneously satisfying the rules for minimum annual withdrawals from qualified plans. Please note that the executor needs to make the QTIP election under §2056(b)(7) for BOTH the qualified retirement plan or IRA as well as the trust that is named as its beneficiary. Remember too, a QTIP trust must adhere to all the normal distribution rules for trusts. (See item "K".) M. Although an irrevocable trust may be named as the beneficiary of a qualified plan, it is permissible to change to a new irrevocable trust as often as necessary to facilitate alterations in the estate plan. N. Married participants often select their spouse as the primary beneficiary for qualified plans and specify a family trust as the contingent. However, it may cause problems if the non-participant spouse wishes to disclaim all or a portion of the plan benefits. (See item “J”.) While the disclaimer may be valid, one portion (the survivor's trust) of the typical family trust that is named as the contingent beneficiary remains revocable after the death of the first trustor. Proposed Regulation §1.401(a)(9)-4, A-5(b)(2) states that a trust named as the beneficiary of a retirement plan or IRA must become irrevocable on or before the participant's death to satisfy the Designated Beneficiary Rules. Failure to achieve DB status can severely limit the stretch-out potential of distributions to a living trust regardless of the participant’s age at death. Of particular concern is the five-year rule described in §401(a)(9)(B)(ii) when the participant dies before his or her required beginning date. Please note that some commentators feel that the grantor trust provisions spelled out in IRC §671-679 allow the survivor's trust under these circumstances to overcome the irrevocability clause of the new proposed regulations mentioned above. In fact, at least one private letter ruling (LTR 199903050) appears to embrace this conclusion. However, the new proposed regulations mention no exceptions to §1.401(a)(9)-4, A-5(b)(2). Fortunately, there is one sure means by which a plan participant can preserve his or her survivors' right to use the general exception under §401(a)(9)(B)(iii) when a trust is named as the contingent beneficiary and the surviving spouse is the primary beneficiary. To do so, make the contingent beneficiary the portion of the family trust that becomes irrevocable upon death of the plan participant -- not the whole family trust. That is to say, be specific by naming the bypass, credit shelter or QTIP trust as the contingent beneficiary. [§1.401-(a)(9)-4, A-5] O. If the rights to receive plan assets pass to a trust upon the death of a participant, the required distributions will eventually exceed the income earnings of the qualified plan. From then on, the trust will be forced to recognize the principal portion of the required distributions as taxable income to the trust. If the trust in turn passes out that principal to the income beneficiary to avoid a potential 39.6% Federal tax rate, the basic purpose of the trust may be compromised. Imagine the uproar that would emanate from the beneficiary of a remainder interest in a CST or QTIP trust if the surviving spouse, in a second marriage situation, started receiving principal. If a trust needs to be the beneficiary for a qualified plan, be sure the trust defines income and principal as the two words apply to distributions from a qualified plan. This last tip may also help overcome the artificial assumption built into many state uniform principal and income acts that limit income to a very small percentage (only 10% in California) of a required distribution from qualified plans. P. Beneficiaries of the remainder interest in a bypass or credit shelter trust as well as a QTIP trust may have to wait for the death of the income beneficiary, usually the surviving spouse, before receiving benefits, but that is only a timing issue. The remainder persons will receive something, albeit delayed. Therefore, the life expectancy of the remainder beneficiaries must be considered when deciding the Designated Beneficiary with the shortest life expectancy. [§1.401(a)(9)-5, A-7(c), Example 2(iii)] Remember that if a charity or other non-DB has a remainder interest, you have “non-DB status”. (See items “B” and “E”.) Q. Following the death of a participant, a non-spouse DB may name a beneficiary of his/her own to receive the balance of the participant's account if the original DB dies before withdrawing all the funds. The beneficiary's action does not impact the required distribution calculations. For a prolonged period many IRA custodians and trustees felt that this action was not permissible. Fortunately, the new proposed regulations expressly bless it in §1.401(a)(9)-5, A-7(d)(1). R. Rather than execute a spousal rollover, a surviving spouse that is the sole primary beneficiary of a decedent's qualified plan is permitted to leave the assets in that account and postpone required distributions until the year the deceased participant would have attained age 70½. [§401(a)(9)(B)(iv)] This Spousal Exception is often considered when the survivor is younger than age 59½ because the 10% Federal excise tax on pre-59½ distributions does NOT apply when he or she taps the account. In contrast, the exercise tax will apply to early withdrawals from a spousal rollover account. Unfortunately, a surviving spouse that has avoided the 10% excise tax on early distributions because of the exclusion under IRC §72(t)(2)(A)(ii) may lose the right to subsequently transfer the deceased participant's qualified plan to a spousal rollover IRA of his/her own. (See LTR's 9418034 and 9608042 but be sure to contrast them with LTR 200110033.) Please keep in mind that when required distributions finally begin under the Spousal Exception in IRC §401(a)(9)(B)(iv), minimum withdrawals must be computed using the surviving spouse's single life expectancy on an attained age basis, rather than the more favorable values found on the Uniform Table that would apply to a spousal rollover. During the survivor's lifetime, that differential could produce a significant disadvantage in the form of larger taxable distributions. The Spousal Exception is also detrimental if the survivor dies after commencement of required withdrawals. At that point the new proposed regulations force the ultimate beneficiaries (probably the couple's children) to complete those required distributions based on the single fixed-period life expectancy of the surviving spouse established on that person's birthday in the year of death. [§1.401(a)(9)-5, A-5(b)] The new rule effectively compels the children to greatly accelerate withdrawals and, hence, forego the tremendous stretch-out potential that would have been available to them as beneficiaries of a spousal rollover. S. Listing the life expectancy rule as the default method under the new proposed regulations when participants die before the RBD may prevent non-spouse DB's from being forced to adhere to the Five-Year Rule if they forget to withdraw the first required distribution by December 31 of the year after the participant's death. Unfortunately, there is no escape from that quicksand if a qualified plan mandates the Five-Year Rule or uses it as its default in the event a beneficiary fails to make an election to the contrary. However, rescue is possible in cases where a plan stipulates that a non-spouse DB must use the General Exception to the Five-Year Rule, lists that exception as the plan's default if the DB forgets to make an election to use it, or is silent as to what method must be followed if no election is made. In each of the latter three scenarios, the DB may be liable for a 50% excise tax under §4974 on the undistributed required distribution, but he or she will no longer fall victim to the Five-Year Rule. (See §1.401(a)(9)-3, A-4 and Table 24) Return to Introductory Remarks Return to New Rules of the Road Return to New Technical Terms and Concepts Return to New Assorted Planning Pointers
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