Required Minimum Distributions for Traditional and Roth IRAs
By Gregory Kolojeski

 (With permission, January, 1999)

Introduction

At some point, all IRAs must have their balances distributed according to the government mandated Required Minimum Distributions rules. Why are the Minimum Distributions prefaced by the word “Required?”  Simply put, there is a 50% penalty for the amount of Required Minimum Distributions that are not distributed as required.  The Required Minimum Distributions rules are incredibly complex. This article deals with how these rules operate and how they apply to Traditional IRAs and Roth IRAs.

Are Roth IRAs subject to the Required Minimum Distributions rules?

You may sometimes hear or see the statement that Roth IRAs are not subject to Required Minimum Distributions.  That is not really accurate.  Roth IRAs are not subject to Required Minimum Distributions during the owner's lifetime, but are subject to Required Minimum Distributions after the death of the owner.  However, Traditional IRAs are generally subject to Required Minimum Distributions beginning at age 70½.  One of the great advantages of Roth IRAs is that they are not subject to these lifetime Required Minimum Distributions rules.  This advantage may be the single most valuable attribute of a Roth IRA.

To what types of pensions do the lifetime Required Minimum Distributions rules apply?

The lifetime Required Minimum Distributions rules generally apply to the following types of pension plans:

• Corporate and self-employed pension, profit sharing and stock bonus plans qualified under IRC Sec. 401(a) (includes Keogh or H.R. 10 plans, 401(k) plans, and employee stock ownership plans or ESOPs).
  
• Individual Retirement Accounts (IRAs) under IRC Sec. 408(a). 
  
• Simplified Employee Plans (SEPs) under IRC Sec. 408(k).
  
• Tax-sheltered annuities (except for account balances existing on 12/31/86 if kept separate for accounting purposes) under IRC Sec. 403(b).

What are the lifetime Required Minimum Distributions rules?

The Required Minimum Distributions rules generally apply when the owner of the plan reaches what is known as the age 70½ year.  You reach 70½ on the date that is six months after your 70^th birthday.  If you reach age 70 in January through June, that same calendar year will be your age 70½ year.  If you reach age 70 in July through December, your age 70½ year will be the year AFTER your 70^th birthday.  (Only the IRS could come up with rules like this!)

What is the significance of the age 70½ year?

Generally (which means there are some exceptions), you must take a Required Minimum Distribution for the year in which you turn age 70½.  You calculate the Required Minimum Distribution by dividing the IRA balance from December 31^st of the preceding year by a “life expectancy.”  How you arrive at the correct number for your life expectancy is somewhat complex and will be explained later in the article. The IRA distribution rules also depend on whether the owner of the Traditional IRA has reached what is known as the Required Beginning Date.  The Required Beginning Date is April 1^st of the calendar year following the year in which the owner reaches age 70½.  If the owner dies before the Required Beginning Date, the distribution rules are different than if he dies on or after the Required Beginning Date.  The discussion here will focus primarily on what happens if the owner lives at least until his Required Beginning Date.

What is the significance of the Required Beginning Date?

If the IRA owner dies on or after his Required Beginning Date, distributions from the Traditional IRA will be determined by elections he did or did not make. It is very important to consider your distribution options carefully before you reach your Required Beginning Date. Many IRA owners will need to consult with a professional advisor in order to make the best choice. The Required Beginning Date locks-in one’s distributions based on the beneficiary selections and the distributions will only change due to certain other events such as the death of the owner or beneficiary.

Once you have reached the age 70½ year, you must take a distribution each year (i.e., no later than the end of the year) based on the IRA balance as of December 31^st of the preceding year.  (The rule that allows you to distribute by April 1st of the following year is a one-time exception that only applies to the first year.)

The best way to understand this rule to look at an example:

What life expectancies may be used for Required Minimum Distributions?

There are two methods for calculating your life expectancy.  One is known as the automatic refiguring of life expectancy method (i.e., the Recalculation Method).  The other is known as the Term Certain Method.

• The Recalculation Method uses a life expectancy that is taken from an IRS table.  When the Recalculation Method is chosen, the life expectancy will generally decrease by less than 1.0 per year.
  
• The Term Certain Method starts with a life expectancy taken from an IRS Table, but that value will be decreased by 1.0 for each successive year.

The Recalculation Method results in longer life expectancies, but it becomes a 0 (zero) life expectancy in the year after the person dies.  The Term Certain Method goes down by 1.0 per year and is unaffected by when you die.  Depending on how long you live, the Term Certain Method may reach 0 before you die or after you die.  What is the significance of the life expectancy reaching 0?  Unless some other life expectancy becomes the controlling one, the entire Traditional IRA balance must be distributed in the year the life expectancy becomes 0.

Life expectancies may be single life or joint life expectancies.  (There is no apparent advantage to ever choosing a single life expectancy if one has the option of using a joint life expectancy.) Joint life expectancies are based on two lives.  When one is using a joint life expectancy, it is possible for one of the life expectancies to be based on the Recalculation Method while one is based on the Term Certain Method.

As a ‘non-spousal beneficiary’, your life’s partner may only use the Term Certain Method and may never rollover an IRA and become the owner. Furthermore, while the owner is alive, a non-spousal beneficiary must apply what is known as the MDIB rules (IRC Proposed Treas. Reg. Sec.1.401(a)(9)-2).  The MDIB rule requires that no (non-spousal) distribution which occurs after the Required Beginning Date be less than the one calculated by dividing the Plan Balance by the factor from the MDIB Table divisor from IRC Proposed Treas. Reg. Sec.1.401(a)(9)-2, Q-4.  (Effectively, this requirement is triggered when the ‘non-spousal beneficiary’, such as your life’s partner, is more than ten years younger than you; he or she will be deemed to be no more than ten years younger than you regardless of his/her actual age).

General Rule:  Always use a joint life expectancy when possible.  Required Minimum Distributions based on two lives will provide for much longer distribution periods and smaller Required Minimum Distributions than those based on single life expectancies.  Assuming that joint life expectancies are being used, the choices become the following:

• If both the owner and beneficiary are using the Term Certain Method, the life expectancy in each year is set to their joint life expectancy in the 70½ year minus the number of years which have passed since then.
  
• If one is using the Recalculation Method and the other the Term Certain, the life expectancy in each year is determined using the method from IRC Proposed Treas. Reg. Sec. 1.401(a)(9)-1, E-8(b).  This complicated hybrid method uses a modified age for the person who has elected not to recalculate based on the deemed age for the Term Certain life expectancy.  With that deemed age for the Term Certain Method and the actual age for the person using the Recalculation Method, a joint life expectancy is selected from Table VI.
  

Professional advisors will often recommend the choice of a hybrid method with older person (assumed to be IRA owner for this discussion) using the Recalculation Method and the younger person using the Term Certain Method.  If the younger beneficiary dies first, use of the Term Certain Method continues with a joint life expectancy continuing to be used while the owner is alive.  After the owner dies and his Recalculation Method goes to 0, any remaining Term Certain life expectancy will continue to determine the distributions.

Jim’s Comment: I cannot stress too much the importance of choosing for yourself which method of distribution is optimal for your situation. If you do not make a choice, the plan administrator or the company that is investing your funds is likely to make a choice for you.  Unfortunately, the choice the investing company makes is quite often far less than optimal.  It is absolutely critical that before you begin taking minimum distributions, you make the proper determination of which method of distribution is best for your circumstances, and it is equally critical that you formally communicate those choices to the plan administrator or company holding your retirement assets.  This is an area where I recommend professional guidance because the laws are so complex.  The importance of optimizing this election cannot be overstated.

Another critical election comes after the death of an IRA owner.  A beneficiary would be well advised to find out all of his/her options and make the appropriate election.  If it is available, the election to take minimum distributions from the inherited IRA over the beneficiaries’ life expectancy can result in enormous tax-deferred growth.  IRA owners should inform beneficiaries or trustees for young beneficiaries that it is imperative to seek the proper professional advice after the IRA owner’s death.

What are the Required Minimum Distributions for Roth IRAs?

Roth IRAs are not subject to the lifetime Required Minimum Distribution rules since no distributions are required during the lifetime of the owner.  However, Roth IRAs are subject to Required Minimum Distributions rules after the death of the owner of the Roth IRA with a 50% penalty if such distributions are not made.  The IRS released its interpretation of the Roth IRA Required Minimum Distributions rules in Article V of IRS Form 5305-R (Roth Individual Retirement Trust Account).  That form is a model trust agreement that most financial institutions are likely to use (or to incorporate in their own agreements).

Let's assume the owner of the Roth IRA has died and that the beneficiary is now subject to Required Minimum Distributions rules.  The beneficiary will have to start taking distributions over the beneficiary's life expectancy starting no later the December 31^st of the year following the year of the owner's death.  If distributions to the beneficiary do not start by December 31^st following the year of the owner's death, the rules require a complete distribution of the plan balance within five years.  So it is very important to properly start distributions in the year after the owner's death if one wants to be able to take best advantage of the Roth IRA.  Generally, a written election to this effect should be filed with the plan administrator as soon as possible.

How are Required Minimum Distributions calculated for the beneficiary of a Roth IRA?

Let's assume a Roth IRA owner who was born on January 1^st dies at the age of 90 and leaves the Roth IRA to his chosen beneficiary, who becomes 60 years old during that year.  The chosen beneficiary would have to take his first distribution in the year after the owner's death or in a year when he would be 61.  The single life expectancy from the IRS tables for a 61-year-old is 19.2 years.  So in that year, he would have to withdraw an amount equal to the preceding year's December 31^st balance divided by 19.2.  The next year, he would reduce the life expectancy value by 1 to 18.2 and then by 1 to 17.2 in the following year and so on.  This is the same Term Certain Method referred to earlier.

The Term Certain Method is the only method available to a non-spousal beneficiary. One attribute of this method is that it does not depend on the beneficiary's actual life expectancy.  If one lives long enough, the entire balance will have been distributed.  If one dies before the end of the payment period (effectively a 20-year pay out period in the example), the payment stream could continue to the chosen beneficiary if the funds are not fully withdrawn earlier.

Note:  Some IRA Agreements require a full distribution after the death of the beneficiary.

Jim’s comment:  Same sex couples should be aware that many 401(k) plans still specify that upon the death of the owner, if a ‘non-spouse’, such as your life’s partner, is your chosen beneficiary, then the income tax on the entire amount of the 401(k) plan is due and payable by your life’s partner in the year of your death.  That is a brutal policy that impacts same sex couples, but one that endures for many companies.  Therefore, if you are retired and still have significant funds in a 401(k), it is well worth examining the terms of the plan and considering rolling that money into an IRA to extend the distribution period in the event you die with a balance in your account.

Summary

The Roth IRA Required Minimum Distributions rules are considerably easier than the incredibly convoluted distribution rules for Traditional IRAs.  The possibility of making mistakes is lessened considerably thus reducing the chances of expensive mistakes.  And longer periods of tax-free compounding will generally occur with the Roth IRA.  The biggest problem with the Roth IRA Required Minimum Distribution rules is that the beneficiaries may not be aware of their requirement to take such distributions.  Anyone who starts a Roth IRA would be well advised to inform the beneficiaries that they must take distributions after the death of the owner or be prepared to pay a 50% penalty on amounts that should have been distributed.  Of course, beneficiaries of Traditional IRAs have the same concerns with the addition of much more complexity.  As far as the distribution rules are concerned, the Roth IRA is an easy winner when compared to a Traditional IRA. 

James Lange is a tax attorney and CPA who provides specialized retirement and estate planning services for gay and lesbian individuals and couples with significant retirement plan accumulations.  He has prepared over 450 simple and complex retirement and estate plans.  These plans include tax-savvy advice, will and trust preparation, and sophisticated beneficiary designations for IRAs and other retirement plans. You can contact Jim by phone at (800) 387-1129, or (412) 521-2732, or by e-mail at admin@outestateplanning.com.