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Life
Simplified and Sweetened—Sweeping Changes for IRAs and Retirement
Plans
by James
Lange, CPA, JD
It's Christmas
all over again for IRA owners and participants in employer sponsored
retirement plans such as 401(k)s, 403(b)s, etc.
Without bothering to consult the president or the Congress,
the IRS has made sweeping changes in the rules governing the distributions
of IRAs and retirement plans both when the IRA owner reaches 70
½ and after the IRA owner dies.
Though billed
as “New Proposed Regulations on Required Minimum Distributions”
for all practical purposes, the new rules are effective immediately.
(The previous set of proposed regulations in this area, passed
in 1987, were never made final but practitioners have followed the
proposed regulations as the law since 1987.)
The IRS has said “IRA owners may therefore rely on these
proposed regulations for distributions for the 2001 calendar year.”
IRA owners may continue to use the existing rules for the
year 2001, but so far, I see no reason why anyone would want to.
If you are interested
in learning what your new Minimum Required Distribution is, please
visit my new Minimum Required
Distribution Calculator.
Calculating your MRD for 2001 according to the new regulations
is easy -
simply plug in two entries: your date of birth and the combined balance from your IRA and
retirement plans and press “calculate.”
You can also calculate it “manually” by using the new “Uniform
Withdrawal Factor” table on the same site.
Unfortunately,
retired employees, whose money is still in a
company plan that has not amended their plan document can't use
the new tables.
As
I and other IRA experts have more time to read and interpret the
proposed regulations, I will be sending out more information.
In the meantime, here is the second edition of this newsletter
containing the “meat” of the new proposed legislation:
Background
Until
now IRA owners and/or participants in most retirement plans were
subject to extremely complex rules stipulating how much money they
were required to withdraw from their IRA or retirement plan.
The minimum required distributions for IRA owners commenced
when they reached 70 ½. Some
retirement plan participants could delay their minimum required
distributions until after they retired.
Distributions from an IRA or retirement plan are taxable
for federal income tax purposes. Given that, IRA owners who did
not have an immediate need for the IRA distribution had a huge incentive
to do everything they could to lower their minimum required distribution.
The
amount of the minimum required distribution was calculated by dividing
the balance in the account on December 31 of the previous year by
a number derived from the life expectancy of the owner and the beneficiary.
There were different methods of calculating life expectancy
including the recalculation method, the term certain method and
even a hybrid method. The
minimum required distribution differed substantially depending on
who was named as the primary beneficiary.
To make matters worse, once these elections were made, the
IRA owner set in stone a distribution pattern that could not be
slowed down after April 1 of the year following the year the IRA
owner turned 70½. If
the surviving spouse was named the primary beneficiary but predeceased
the owner, there was usually a massive acceleration of taxes both
at the first and second death.
It was a mess.
New
Law
The
concepts of recalculation and term certain and hybrid with respect
to calculating life expectancy are now only of historical interest.
With only one exception, the minimum required distribution
is calculated based on the joint life expectancy factor of the IRA
owner, starting at age 70, and the life expectancy of someone who
will be considered to be ten years younger than the IRA owner, no
matter what their actual age or life expectancy may be.
That life expectancy factor will decrease as the IRA owner
ages. “Using the MDIB
table, most employees (the IRS also includes IRA owners) will be
able to determine their minimum required distribution for each year
based on nothing more than their current age and their account balance
as of the end of the prior year (which IRA trustees report annually
to IRA owners.)” The only exception is when your spouse is 10 or
more years younger than you are.
In that case, the IRS will allow you to use your actual joint
life expectancy. Most
participants who currently receive minimum required distributions
will now be able to enjoy a lower minimum required distribution
using the MDIB. The term MDIB is replaced with the “Uniform Table”
because subject to the one exception mentioned, it applies to everyone.
You can determine your new MRD by using either my new
calculator or the new “Uniform Withdrawal
Factor” table.
Minimum
Required Distributions After the Death of the IRA Owner
Planning for
and applying the old MRD rules after the death of an IRA owner (now
called the applicable distribution period) was like trying to cross
a swamp of quicksand loaded with minefields. The penalty for “getting caught” without a plan was a massive
acceleration of income taxes for the heirs. Beneficiaries who did
not immediately need the proceeds of the inherited IRA were better
off leaving the money in the tax-deferred environment of the IRA.
To achieve the “stretch” required thoughtful and complicated planning.
Planners had to take into consideration a variety of factors including
the named beneficiary when the owner turned 70 ½, whether the surviving
spouse predeceased the IRA owner, the methods chosen to calculate
life expectancies, and whether a special election, that had to be
made by either the surviving spouse or non-spouse beneficiaries,
was filed in a timely fashion.
Under
the new rules:
- If the beneficiary
is the surviving spouse, the rules about making an IRA rollover
into the spouse's own IRA are clarified, but not substantially
altered.
- If
the beneficiary is a non-spouse, they will be required to take
minimum required distributions over their life expectancy.
When
to Name a Beneficiary
We
no longer have to worry about who was or was not the named beneficiary
on April 1 of the year following the year the IRA owner turned 70
½, i.e., the IRA owners required beginning date (RBD).
Now, the life expectancy of the beneficiary is determined
after the IRA owner dies. It is not dependant on who or how old the beneficiary was when
the IRA owner reached his RBD.
In the words of the IRS “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.”
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