Minimum Distributions from Retirement Accounts

Last year, the IRS proposed regulations that overhauled the rules concerning required minimum distributions (RMDs) from individual retirement accounts (IRAs), 401(k) plans, and most other tax-favored retirement plans. The RMD rules ensure that money held in tax-deferred retirement accounts is eventually paid out and taxed. The rules apply to required distributions made both before and after the account owner’s death. The 2001 changes greatly simplified the RMD calculation for account owners and their beneficiaries.

Recently, the IRS issued final regulations that include several modifications to the 2001 proposed regulations. These changes make the final RMD rules even more beneficial, especially for those who want to "stretch out" their required retirement account distributions as long as possible.

Under the pre-2001 rules, retirement account owners generally locked in their minimum distributions by selecting a beneficiary and a calculation method by their "required beginning date". In general, the required beginning date is April 1 of the calendar year following the later of (1) the year in which the account owner turns age 70 1/2 or (2) the year in which the account owner retires. For IRA owners or employees who are more than 5 percent owners of the employer sponsoring the retirement plan, the required beginning date is April 1 of the calendar year following the year in which they turn age 70 1/2. Under both the proposed and final rules, the required beginning date remains the same. However, the calculation of the amount of each year’s minimum distribution is simplified by using an age-based factor from a uniform table.

The final rules adopt a newly revised life expectancy table that, in effect, increases the age-based factor used in the RMD calculation — and reduces the amount of the minimum distributions. For example, the new uniform table uses a life expectancy of 27.4 years at age 70 versus the 26.2 years found in the table contained in the 2001 proposed regulations. So, an individual with a $100,000 IRA balance who turns 70 1/2 in late 2003 will have to take a required minimum distribution of approximately $3,650 by April 1, 2004, as opposed to a RMD of $3,817 under the 2001 proposed rules.

As in the proposed rules, the final rules exempt an account owner whose spouse is the sole beneficiary of his or her account from having to use the uniform table if the spouse is more than 10 years younger than the owner. In this situation, distributions may be based on the couple’s longer joint life expectancy, thereby allowing them to stretch out the distributions over more years.

The new rules simplify minimum distributions from inherited retirement accounts. If there is a designated beneficiary for the account, RMDs are usually based on the beneficiary’s life expectancy. Under the final rules, the deadline for final designation of a beneficiary is September 30 of the year following the account owner’s death. This provides the time necessary to calculate and process the RMD by the deadline for the first minimum distribution to a nonspouse beneficiary, December 31 of the year following the date of death. The final rules clarify that, while a beneficiary can be removed during the period between death and the final designation, a beneficiary cannot be added during that time.

Under the final rules, therefore, careful planning could provide advantages in certain cases. In the case where multiple beneficiaries are named, the life expectancy of the beneficiary with the shortest life expectancy generally will be used to calculate the RMD amounts for all of the beneficiaries. However, if the retirement account is divided into separate accounts by the end of the year after the year of death, then each beneficiary may use his or her own life expectancy in computing the required minimum distribution.

In addition, if a designated beneficiary disclaims rights to an account within nine months after the account owner’s death and, as a result, the disclaimed benefits then pass to a younger beneficiary named by the account owner, the older beneficiary will not be taken into account in determining the RMD. Rather, the younger person’s life expectancy will be used. This would result in a longer required distribution period and the account funds could remain tax-deferred over a longer period. For example, if a now-deceased IRA owner named his son and grandson as beneficiaries of the account, the son could waive all rights to the account and the grandson’s life expectancy would then be used to calculate the minimum distribution.

Note that different rules apply if the owner does not name a beneficiary for the account. In that situation, the account balance is paid out over the remaining table life expectancy of the account owner, assuming the account owner dies after the required beginning date. If the account owner dies before the required beginning date, the account balance generally must be distributed within five years after the owner’s death.

Roth IRAs are not subject to the RMD rules until after the original Roth IRA owner dies. Then, the beneficiaries must follow the same minimum distribution rules that apply to traditional IRAs.

The IRS has also created a new reporting system so that it may better enforce the rules on required IRA distributions. Starting with RMDs for 2004, the IRS must be notified by the IRA provider that an IRA owner is subject to the RMD requirements. However, the amount of the RMD is not reported to the IRS. By January 31, 2003, for the 2003 tax year, IRA providers must either report to the IRA owner the RMD amount or inform the owner that an RMD is required and that the provider will calculate the RMD amount for the owner upon request.

The final regulations become effective for determining required minimum distributions for 2003 and later years. However, IRA owners may elect to use the final rules for their 2002 distributions (or they may choose to use either the rules proposed in 2001 or the rules that existed before the 2001 proposed regulations). Qualified retirement plan participants can take advantage of the revised rules in 2002 only if the sponsor of the plan amends the plan to allow the new treatment for 2002. Plan amendments must be made by the end of the plan year starting on or after January 1, 2003.

If you are a retirement account owner who is currently receiving distributions, you may be able to reduce your minimum distributions from the levels required under the old rules. And, if you have a retirement account you inherited from someone else, you may also be able to make beneficial changes immediately. Accordingly, if you are interested in reducing the amount of your minimum retirement account distributions, please make an appointment with us to examine your options.

The information provided in the newsletter has been obtained from sources believed to be reliable but its accuracy is not guaranteed.