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Finalized Regulations
for Retirement Plan Distributions
by: James
Lange, CPA, JD
and Geraldine
S. Skupien, JD
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
on our web site. 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 on
our web site. 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.
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