New Proposed Retirement
Plan Distribution Rules
Reprinted with permission of Michigan Lawyers Weekly
The number one obstacle to wealth accumulation is taxation! Some might disagree with this statement after reviewing last year’s stock market performance. However, with combined federal and state income tax rates approaching 45 percent at the top end and federal estate taxation at 55 percent at time of death, last year’s stock market results don’t look so bad — especially when compared with returns from the average S&P 500 Index fund in the Morningstar database during 2000, which delivered a negative 9.51 percent return. It is not unusual for large retirement plans to lose upwards of 70 percent in taxation if distributions are done without proper planning at time of death.
The solution to taxation is deferral — for as long as possible. A surprise move by the IRS on Jan. 11, 2001 introduced major changes to the rules that govern distributions from IRAs and other qualified plans. These changes are proposed revisions to IRC section 401(a)(9), which were last revised in 1987. It will be hard to find anyone with retirement plan assets who is not impacted for the better. The opportunity to take reduced required distributions includes (almost) everyone:
• who is already past his or her required beginning date; and/or
• whose required beginning date is April 1, 2001.
The revisions may permit some favorable change in the required distributions for anyone who has inherited a retirement plan from a person who died after 1999 and, in some cases, any person who inherited a retirement plan from a person who died earlier than the year 2000.
The application of these regulations become mandatory on Jan. 1, 2002. However, taxpayers may apply these new proposed regulations beginning on Jan. 1, 2001 and perhaps to some decedents who died in 2000. Because these proposed regulations for required minimum distributions comprise almost 60 pages they will take some time for advisors to review. In fact, the IRS has set up a public hearing on these for June 1, 2001 to solicit comments from advisors.
As an attorney, it would be advisable to postpone your client’s 2001 required minimum distribution (RMD) until you have determined the RMD under the new tables which can be seen at www.logos4me.com. Look for “New IRS Regs” in the upper right corner for the “New Pro-posed MDR Regulations” button; the table is on page 26.
There is also an update from Steve Leimberg’s Employee Benefits and Retirement Planning E-mail Newsletter — www.leimberg.com — which states: “There will be a 60-day moratorium on final IRS regulations, which have not taken effect as of January 20, 2001, as well as the IRS proposed regulations, which have not been finalized by January 20, 2001. No one knows for sure what this will mean, except that these proposed regulations are on hold for 60 days. Close attention is required since 60 days will get you close to the April 1, 2001 date. It is un-clear at this point if the effective date will be January 1, 2001 when the moratorium is lifted or some new date.”
Language from the new proposed regulations follows:
“SUMMARY: This document contains pro-posed regulations relating to required minimum distributions from qualified plans, individual retirement plans, deferred compensation plans under section 457, and section 403(b) annuity contracts, custodial accounts, and retirement income accounts. These regulations will provide the public with guidance necessary to comply with the law and will affect administrators of, participants in, and beneficiaries of qualified plans; institutions that sponsor and individuals who ad-minister individual retirement plans, individuals who use individual retirement plans for retirement income, and beneficiaries of individual retirement plans; and employees for whom amounts are contributed to section 403(b) annuity contracts, custodial accounts, or retirement income accounts and beneficiaries of such contracts and account.”
Many of the comments on the 1987 proposed regulations addressed the rules for required minimum distributions during an employee’s life, including calculation of life expectancy and determination of designated beneficiary. In particular, comments raised concerns about the default provisions, election requirements, and plan language requirements. In general, the need to make decisions at age 70-1/2 , which under the 1987 proposed regulations would bind the employee in future years during which financial circumstances could change significantly, was perceived as unreasonably restrictive. In addition, the determination of life expectancy and designated beneficiary and the resulting required minimum distribution calculation for individual accounts were viewed as too complex.
To respond to these concerns, these proposed regulations would make it much easier for individuals — both plan participants and IRA owners — and plan administrators to understand and apply the minimum distribution rules. The new proposed regulations would make major simplifications to the rules, including the calculation of the required minimum distribution during the individual’s lifetime and the determination of a designated beneficiary for distributions after death.
The new proposed regulations simplify the rules by:
• providing a simple, uniform table that all employees can use to determine the minimum distribution required during their lifetime. This makes it far easier to calculate the required minimum distribution because employees would no longer need to determine their beneficiary by their required beginning date; no longer need to decide whether or not to recalculate their life expectancy each year in determining required minimum distributions; and no longer need to satisfy a separate incidental death benefit rule.
• permitting the required minimum distribution during the employee’s lifetime to be calculated without regard to the beneficiary’s age (except when required distributions can be reduced by taking into account the age of a beneficiary who is a spouse more than 10 years younger than the employee).
• permitting the beneficiary to be determined as late as the end of the year following the year of the employee’s death. This allows the employee to change designated beneficiaries after the required beginning date without increasing the required minimum distribution and the beneficiary to be changed after the employee’s death, such as by one or more beneficiaries disclaiming or being cashed out.
• permitting the calculation of post-death minimum distributions to take into account an employee’s remaining life expectancy at the time of death, thus allowing distributions in all cases to be spread over a number of years after death.
These simplifications would also have the effect of reducing the required minimum distributions for the vast majority. The new Table for Determining Applicable Divisor in many cases will reduce the current RMD by over 40 percent in the case of a 75 year old. That means the money grows tax-free longer before giving up to 40 percent away to the IRS. In addition, the calculations are now much easier.
These proposed regulations provide that, generally, the designated beneficiary is determined as of the end of the year following the year of the employee’s death rather than as of the employee’s required beginning date or date of death, as under the 1987 proposed regulations. Thus, any beneficiary eliminated by distribution of the benefit or through disclaimer (or otherwise) during the period between the employee’s death and the end of the year following the year of death is disregarded in determining the employee’s designated beneficiary for purposes of calculating required minimum distributions. If, as of the end of the year following the year of the employee’s death, the employee has more than one designated beneficiary and the account or benefit has not been divided into separate accounts or shares for each beneficiary, the beneficiary with the shortest life expectancy is the designated beneficiary, consistent with the approach in the 1987 proposed regulations.
The ability under the new regulations to “fix” a beneficiary designation by December 31st of the year after death is perhaps the most important change. It will allow beneficiaries the opportunity to enjoy longer distributions without regard to the election made by the IRA owner’s RMD. This will allow post-death estate planning to take place and disclaimers to affect beneficiaries where the spouse disclaims to the children and the children to their children. In addition, where death has occurred there may be an opportunity to separate the IRA via a vertical division that each beneficiary could then distribute over his/her own life expectancy, thus increasing the tax-free period.
These proposed regulations retain the provision in the proposed regulations, as amended in 1997, allowing an underlying beneficiary of a trust to be an employee’s designated beneficiary for purposes of determining required minimum distributions when the trust is named as the beneficiary of a retirement plan or IRA, provided that certain requirements are met.
One of these requirements is that documentation of the underlying beneficiaries of the trust be provided timely to the plan administrator. In the case of individual accounts, unless the lifetime distribution period for an employee is measured by the joint life expectancy of the employee and the employee’s spouse, the deadline under these proposed regulations for providing the beneficiary documentation would be the end of the year following year of the employee’s death. This is consistent with the deadline for determining the employee’s designated beneficiary. Because the designated beneficiary during an employee’s lifetime is not relevant for determining lifetime required minimum distributions in most cases under these proposed regulations, the burden of lifetime documentation requirements contained in the previous proposed regulations is significantly reduced.
A significant number of commentators on the 1997 amendment to the proposed regulations requested clarification that a testamentary trust named as an employee’s beneficiary is a trust that qualifies for the look-through rule to the underlying beneficiaries, as permitted in the 1997 proposed regulations. These proposed regulations provide examples in which a testamentary trust is named as an employee’s beneficiary and the look-through trust rules apply.
As previously illustrated in the facts of Rev. Rul. 2000-2, 2000-3 I.R.B. 305, the examples also clarify that remaindermen of a “QTIP” trust must be taken into account as beneficiaries in determining the distribution period for required minimum distributions if amounts are accumulated for their benefit during the life of the income beneficiary under the trust.
This means more time is now available to file a copy of the trust! Under the new proposed regulations you have until December 31 of the year following death. In order for the trust to qualify as a designated beneficiary it must:
• be valid under state law;
• be irrevocable or will be at time of death; and
• have the beneficiaries identified in the trust.
Also, you must provide proper documentation to the “plan administrator” by the last day of the calendar year immediately following the calendar year in which the employee died. The old rules provided for nine months after date of death.
Because these regulations substantially simplify the calculation of required minimum distributions from IRAs, IRA trustees determining the account balance as of the end of the year can also calculate the following year’s required minimum distribution for each IRA. To improve compliance and further reduce the burden imposed on IRA owners and beneficiaries, under the authority provided in section 408(I), these proposed regulations would require the trustee of each IRA to report the amount of the required minimum distribution from the IRA to the IRA owner or beneficiary and to the IRS at the time and in the manner provided under IRS forms and instructions. This reporting would be required regardless of whether the IRA owner is planning to take the required minimum distribution from that IRA or from another IRA, and would indicate that the IRA owner is permitted to take the required minimum distribution from any other IRA of the owner.
During year 2001, the IRS will be receiving public comments and consulting with interested parties to assist the IRS in evaluating what form best accommodates this reporting requirement, what timing is appropriate (e.g., the beginning of the calendar year for which the required amount is being calculated), and what effective date would be most appropriate for the reporting requirement. In this context, after thorough consideration of comments and consultation with interested parties, the IRS intends to develop procedures and a schedule for reporting that provides adequate lead time, and minimizes the reporting burden, for IRA trustees, issuers, and custodians in complying with this new reporting requirement while providing the most useful information to the IRA owners and beneficiaries.
The IRS and Treasury are also considering whether similar reporting would be appropriate for section 403(b) contracts.
Overall these regulations greatly simplify distributions from retirement plans while eliminating many of the traps. Large IRAs will require extensive planning in order to avoid remaining traps and to maximize the tax-free accumulation as long as possible. Remember that just about everyone can benefit from these regulations, which become mandatory on Jan. 1, 2002.
John E. Mayer is president of BFA Family Wealth Planners, a registered investment advisor firm with offices in Livonia, West Bloomfield, Ann Arbor and Naples, Fla. With more than 25 years’ experience in estate and financial planning, the firm specializes in counseling closely-held business owners and high net-worth individuals in various tax strategies. He can be reached at (800) 452-4983 or e-mail; firstname.lastname@example.org, website; www.logos4me.com.