IRA Distributions

THE PLAIN ENGLISH GUIDE TO THE NEW REGULATIONS FOR IRA AND QUALIFIED PENSIONS

As you may already know, on January 11, 2000, the IRS issued proposed new regulations governing minimum distributions from 401K plans, IRAs, and other qualified plans.1 The new regulations also allow greater flexibility and more planning options regarding how IRA assets pass on to the next generation. This is a summary of the most important aspects of how the new regulations may affect your income tax planning and personal estate plan. While reading this memo, it is important to understand that while these new rules are definitely less convoluted than under the old regime, there are still traps for the unwary and careful and thoughtful planning is still required.

Determining Your New Minimum Distribution. The new regulations greatly simplify lifetime retirement planning and increase opportunities for income tax deferral. No longer does the amount you must withdraw from your IRA each year after age 70½ depend on elections about recalculation of life expectancy and designated beneficiaries, which often involve complex choices and calculations.

Under the proposed regulations, there are two ways only of calculating annual minimum distributions on an IRA. If you are married and your spouse is more than 10 years younger than you, your annual minimum distribution after age 70½ is determined by the joint recalculated life expectancies of you and your spouse. If, like most of people, you are either unmarried, or you are married and your spouse is not more than 10 years younger than you, your minimum distribution is determined under a new “Uniform Table.” (Attached as Appendix A.)

Please note that the term “designated beneficiary” is defined under the tax laws to exclude charities, your estate, and certain types of trusts. Make sure to discuss your choice of beneficiary with an attorney with knowledge in this area to avoid the harsh results that follow in the event your choice of beneficiary does not technically meet the criteria of the tax definition of “designated beneficiary.” A common mistake is to simply name one’s revocable living trust as the beneficiary. Unless the living trust has been drafted to anticipate such a beneficiary designation, harsh tax consequences are often the end result.

For most people, the Uniform Table requires lower taxable distributions, and therefore more opportunity for tax deferral, than under the old regulations. Some commentators estimate that a typical taxpayer will reduce income taxes from 20 percent to 40 percent over their lifetime.

Example: Horace turns 74 in the year 2001 and has a $500,000 IRA. He is married to Ruth, age 65. Horace’s minimum required distribution for 2001 from his IRA is determined by dividing the IRA balance of $500,000 by the applicable divisor from the Uniform Table (22.7). Horace’s minimum required distribution is $22,026. This is his 2001 required distribution from his IRA regardless of who he has named as his designated beneficiary and without regard to any election of recalculation or term life expectancy.

New Way of Determining Your Designated Beneficiary. Under the old regulations, one was required to select a “designated beneficiary” before age 70½, at which time the selection became irrevocable. Under the new regulations, the identity of your designated beneficiary is not determined and fixed until after your death at the “determination date,” defined as December 31 following the year of your death. You may also change your designated beneficiary anytime and any number of times during your lifetime regardless of your age. The ultimate identity of your beneficiary can change even after your death before December 31 of the following year. The balance of your IRA at death will be distributed over the life expectancy (not recalculated) of your designated beneficiary based on the beneficiary’s age on the “determination date.”

Example: Assuming Fred, a single man, dies with an IRA of $100,000 naming his son Lamont as beneficiary. On December 31 of the year after Fred’s death, Lamont is 50 years old and has a remaining life expectancy of 25 years. The annual minimum distribution to Lamont from Fred’s IRA in the first year will be $4,000 ($100,000 ÷ 25 years). Next year the account balance will be divided by 24 (25-1) to determine that year’s minimum distribution.

The new definition of “determination date” also creates post-mortem (i.e., after death) tax planning opportunities. If you designate multiple beneficiaries (such as “all my children”), the minimum annual distribution for all children normally will be based on the oldest child’s life expectancy (on the determination date). Many commentators believe that under the new rules your children could divide your IRA after your death into separate shares for each child. This would enable each child to schedule withdrawals from their separate IRA share over their individual life expectancies so that younger children could achieve greater income tax deferral. In addition, special planning using “qualified disclaimers" allow for after-death planning opportunities under the new regulations. Disclaimers allow a wealthy beneficiary who does not need distributions from your IRA to disclaim (i.e., refuse to accept) all or part of your IRA thereby allowing the disclaimed assets to pass to younger children or grandchildren. The younger generation would then be able to take advantage of substantially greater income tax deferral during their lifetimes.

Example: Gomez dies in July 2001 leaving his $500,000 IRA to his two children, Parsley and Wednesday. Gomez also leaves his children $2 million of other assets (after tax) so that neither child needs distributions from Gomez’s IRA to maintain a comfortable lifestyle. Anytime prior to December 31, 2002, either child can disclaim in full or in part their share of Gomez’s IRA. Any disclaimed IRA assets will pass to their own children, Gomez’s grandchildren. Thereafter, the grandchildren’s minimum distributions are determined according to their own ages and life expectancies which will obviously be substantially longer.

Spousal Rollover. The rules allowing a surviving spouse to “rollover” an IRA are not changed by the new regulations. In the event of a rollover, the surviving spouse calculates their minimum distributions according to their own age under the Uniform Table, and the IRA would ultimately pass to the surviving spouse’s own designated beneficiaries determined at his or her own determination date.

Effective Date for Minimum Distribution Changes. For those taxpayers receiving distributions from 401K plans, the proposed new regulations will not effect their minimum distribution calculations until either their plan administrator amends the 401K plan document or the proposed regulations become final. More liberal treatment is afforded IRA owners. Any IRA taxpayer may immediately elect to implement the proposed regulations in the year 2001.

Estate Planning. The liberalized regulations primarily affect income taxation during your lifetime. Relatively few changes have been proposed to estate taxation of your IRA. In addition, the increased opportunities for income tax deferral during your lifetime encourages you to take less taxable distributions and accumulate larger IRA balances that will be subject to higher estate tax rates at death. In other words, unless changes are legislated for estate tax rates or credits, what you save in income tax during your lifetime may be offset by increased estate tax liability.

Planning Recommendations.

a. A person currently beyond their required beginning date (70½) and taking minimal distributions from their IRA should immediately investigate the new rules. Implementing the proposed regulations in the year 2001 may reduce their minimum distributions thereby saving income taxes this year and allowing for greater tax deferral.

b. An IRA beneficiary whose participant died in the year 2000 should immediately review their status as designated beneficiary inasmuch as they have until December 2001 to disclaim or divide the inherited IRA account in a manner that may have income tax benefits.

c. Those taxpayers taking distributions from 401K plans should defer their distributions as long as possible (toward the end of this year) in the hope that their plan administrator will amend their plan to make them eligible for the new distribution regulations.

d. People close to or beyond their required beginning date should review their choice of designated beneficiary. Designated beneficiary selections which have been made to date largely to minimize lifetime distributions may now be changed for estate planning purposes without adverse income tax effects.

In planning your IRA distributions, it is important to keep in mind that while tax deferral can be a wonderful thing, in the event you are subject to the estate tax when you pass on, dying with an IRA can be particularly expensive. IRA assets subject to the estate tax can be depleted by 70% or more especially if the generation skipping tax is triggered. Always make sure that you fully understand how IRA planning fits into your estate, otherwise the lure of tax deferral can lead you down a dangerous path.

Conclusion. This memo is a summary of the new regulations and should not be considered legal advice. While the new regulations certainly simplify the law in this area, there are still many traps for the unwary.

The new regulations offer several new planning options, however, planning is still the key.

APPENDIX A
UNIFORM TABLE FOR CALCULATING REQUIRED MINIMUM DISTRIBUTIONS FROM IRAs AND QUALIFIED PLANS
Age Distribution Factor
Age Distribution
Factor
Age Distribution
Factor
70 26.2 85 13.8 100 5.7
71 25.3 86 13.1 101 5.3
72 24.4 87 12.4 102 5.0
73 23.5 88 11.8 103 4.7
74 22.7 89 11.1 104 4.4
75 21.8 90 10.5 105 4.1
76 20.9 91 9.9 106 3.8
77 20.1 92 9.4 107 3.6
78 19.2 93 8.8 108 3.3
79 18.4 94 8.3 109 3.1
80 17.6 95 7.8 110 2.8
81 16.8 96 7.3 111 2.6
82 16.8 97 6.9 112 2.4
83 15.3 98 6.5 113 2.2
84 14.5 99 6.1 114 2.0
115 & Older 1.8