New Technical Terms

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. [§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.