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Finalized Regulations for Retirement Plan
Distributions
by James Lange, JD, CPA
August 2002
The new regulations are
official, and they are better than ever. The biggest substantive change
is the revised mortality table used to calculate minimum required
distributions (MRD). Now taxpayers who are age 70½ or older can opt for
one of three methods for calculating their MRD:
1.
The pre January 11, 2001
methods.
2.
The January 11, 2001 “uniform
life expectancy table.”
3.
The revised “uniform life
expectancy table” issued on April 17, 2002.
The latest
revised table projects longer life expectancies. A longer life
expectancy factored into your balance reduces the MRD. Therefore,
keeping in mind our maxim “pay taxes later,” we recommend that most
clients use the updated “uniform life expectancy table.” Remember, you
will need to contact your institutions’ benefits advisor to
inform them of your choice.
The final regulations
require immediate action on the part of IRA and retirement plan owners
who are past age 70½ and currently taking MRDs. The finalized
regulations will also have an impact on beneficiaries of IRAs and
retirement plans.
At first look, the
changes in the mortality tables do not seem as dramatic as you might
expect for a 20-year mortality table update. However, the cumulative
benefits of the lowered MRD could be substantial.
For example, assume a
taxpayer has reached age 70½ and he or she is required to begin taking
distributions from his or her retirement plan. The taxpayer has $1
million in the account with an 8% rate of return. Since he or she has
other sources of income, the taxpayer wants to invoke our mantra “Don’t
pay taxes now, pay taxes later,” and only withdraw the MRD. If the
taxpayer only withdraws the annual MRD during his or her life, the
taxpayer will have over $125,000 more in his IRA at age 90 than he or
she would have had under the old rules.
To calculate your new
MRD, please turn to our updated minimum distribution calculator. If you are interested in how the new rules impact the MRD for
the beneficiary of your IRA or qualified retirement plan, please use the
new calculator. You can also
click on a link to the new tables if you want to make the calculation
“manually.”
Do I Have to
Update my Will and Beneficiary Designation of the IRA?
If your estate planning
documents were drafted after January, 2001, and your Wills and the
beneficiary designations of your retirement plans use Lange’s
Cascading Beneficiary Designation (see Jim’s article,
MRDefenses, as appeared in the March
2001 issue of Financial Planning magazine, Copyright 2001
by Thomson Financial Investment Marketing Group), you only need to
notify your institution of your request for lowered MRDs per the new
life expectancy tables.
For individuals with
Wills and beneficiary designations that were prepared before January 11,
2001, you (or more accurately your heirs) will likely benefit from
updating your Wills and beneficiary designations consistent with our
recommendations in MRDefenses.
Furthermore, having a “preventive financial health check-up” combined
with updating your estate planning documents is almost always a good
idea.
More Technical Information -- Generally
of More Interest to Advisors than Clients
The regulations as
proposed last year provided that a designated beneficiary of an IRA was
determined as of December 31 of the year following the IRA holder’s
death. This was one of the most popular and favorable aspects of the
regulations. For most cases, this allowed beneficiaries to be paid in
full, disclaimers to be effected, and accounts to be divided to take
advantage of the greatest possible “stretch” based on different
beneficiary life expectancies.
The problem with the December 31 date was
that if the beneficiary had to take a distribution during that same
year, and the determination was not made until December 31, there was no
time to make the proper distribution. In the final regulations, the
designated beneficiaries must be determined by September 30 of
the year following the year of the IRA owner’s death. This will allow
sufficient time for the beneficiary to calculate and take his or her
first MRD of the inherited IRA prior to December 31 of the applicable
year.
The IRS has also
clarified what happens if a designated beneficiary dies between the date
of the IRA holder’s death and September 30 of the following year.
In that case, the original beneficiary continues to be the measuring
life for determining the distribution period, rather than any successor
beneficiary.
The regulations also
stipulate that if any named beneficiary wishes to disclaim his or her
inherited plan benefits, the disclaimer must meet the rules of a
qualified disclaimer under Section 2518 of the Internal Revenue Code.
That means that the beneficiary must comply with all state laws
regarding a qualified disclaimer that is usually within nine months for
the disclaimer to be effective.
The IRS will
Continue to Punish IRA Owners Who Do Not Plan
One major
disappointment in the final regulations is that the IRS has not
mitigated the harsh affect of the designated beneficiary rules when an
IRA owner dies without naming a beneficiary on the IRA or
retirement plan when there is a beneficiary entitled to the IRA
or plan benefits under the Will or by intestate succession. It is
amazing to me that many taxpayers don’t bother to have Wills drafted or
complete the retirement plan or IRA beneficiary designation. Remember:
the beneficiary to a retirement account must be named before the
account holder’s death or the deserving person will be denied the
advantages of the beneficiary’s minimum distribution rules. During the
period between the IRA owner’s death and the beneficiary determination
date (now September 30 of the following year), beneficiaries can be
eliminated but they cannot be added. As I have been preaching for
over 20 years, it is critical that you name beneficiaries for your IRAs
and qualified plans under the administrative rules of the particular
plan to take greatest advantage of tax-deferred growth over the life
expectancies of your selected beneficiaries.
There is another good
reason to ensure that you have named beneficiaries to your IRAs and
qualified plans. The final regulations retain the proposed rule
that if you have a designated beneficiary and you die before your
required beginning date for taking minimum distributions (generally age
70½),your beneficiary gets to take advantage of the “life expectancy
rule” rather than the “five-year rule.” The five-year rule forces
distribution (and taxation) of all your IRA or qualified plan benefits
by the end of the fifth year following the year of your death. The
“life expectancy rule” allows your beneficiary to take distributions
over his or her life expectancy—hence longer tax deferred growth. Prior
to the 2001 proposed regulations, the five-year rule was the default
when an IRA owner died before age 70½ . For beneficiaries already
subject to the five-year rule before the 2001 proposed regulation
change, the final regulations contain a transition rule that may allow
the beneficiaries to switch to the more favorable life expectancy
method.
Trust
Beneficiaries
IRA owners who have
named or wish to name a trust as the designated beneficiary of their IRA
or qualified plan, but want to use the life expectancy of the underlying
beneficiary of the trust for determining MRDs must provide documentation
of the underlying beneficiaries to the trustee or custodian of the IRA
or qualified plan by October 31 of the year following the year of
the IRA owner’s death—not December 31 as was proposed. Once again,
there is a correction period for old trusts that did not qualify because
they hadn’t met this documentation requirement.
Reporting
Requirements
Last year’s proposed
regulations contained a requirement that IRA trustees and administrators
report to the IRS the amount of the MRD from an IRA (according to “TBA”
IRS procedures). Lobbyists from banks and other financial institutions
cried bloody murder. The IRS has backed off on this reporting
requirement for the moment. For 2003, the trustee or administrator must
report to the IRA holder (not the IRS) the MRDs. In 2004, the trustee
or administrator must identify, on Form 5498 filed with the IRS each
year, each IRA subject to the minimum distribution requirements. While
there is no reporting requirement for minimum distributions to
beneficiaries at this time, the IRS maintains that the agency has
adequate authority to require such reporting and states that because it
has concerns about the level of compliance in this area, it intends to
monitor the effect of the new reporting requirements on overall
compliance.
Pension
Excise Taxes
What happens if you
don’t take the full amount of your required minimum distribution? If
the amount distributed to a payee under any qualified retirement plan,
pension, IRA, or 457 deferred compensation plan is less than the MRD,
the payee is subject to an excise tax equal to 50% of the shortfall.
This penalty tax now applies to required distributions from Roth IRAs as
well. Remember, the original owner of the Roth IRA does not have to
take minimum distributions, but the beneficiary of a Roth IRA does.
Although the beneficiary will not be taxed on the distribution from the
Roth if it is a qualified distribution, the beneficiary will be subject
to an excise tax penalty if he or she fails to take the MRD.
Effective
Date
The new regulations
apply for MRDs for tax year 2003. For 2002, taxpayers may compute
their required distributions using these regulations, the 2001 proposed
regulations, or the original regulations proposed in 1987 that were
never finalized. Otherwise, the regulations take effect on January
1, 2003.
James Lange is a tax attorney and CPA who provides
specialized retirement and estate planning services to same sex 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.
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