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Guest Article (6/21/2002)

The New And Final Regulations For Minimum Distributions From Retirement Plans -- The 15 Essential Points

By Thomas J. Murphy, Esq.

On April 16, 2002, the Internal Revenue Service issued its long-awaited final regulations for minimum distributions from retirement plans. The proposed regs, some of which have been in existence since 1987, have finally been replaced. The new regs largely track the favorable changes implemented by the 2001 proposed regs. The overriding theme is of clarifying those regs.

The new regs continue the important trend set by last year's developments with the proposed regs and EGTRRA -- taxpayers can put more money into these plans and leave the money in the plans for a longer period of time. It will now be almost impossible to outlive a plan if only minimum distributions are taken. The flip side of this is that more people will be inheriting larger retirement plans. Grappling with these issues will become a very significant portion of an estate planning practice.

After reading through 155 pages of the new regulations, here are the 15 salient points that practitioners need to know:

#1. New Life Expectancy Tables

Last year's tax bill required the IRS to update the life expectancy ("LE") tables to reflect the year 2000 census. The tables then in use dated back to the 1970's. The updated tables now add about one year to the LE tables. For instance, the Owner/Participant ("OP") at age 70.5 now has 27.4 years rather than 26.2 years to receive distributions.

The new regs use the same three LE tables from last year's proposed regs. First, there is the Uniform Lifetime Distribution Table. This is used during the OP's lifetime. The second table is the Joint Life Table. This is used when the OP has a spouse who is the sole beneficiary ("B") and is more than 10 years younger than OP. The third table is the Single Life Table. This is used for all beneficiaries who are inheriting the retirement plan.

#2. New Beneficiary Disclosure Date - Sept 30th

One of the big changes in the 2001 proposed regs was that the designated beneficiary was not determined until Dec. 31st of the year following the year of the OP's death. This date has now been moved up to September 30th of the year after death. This was done at the request of plan administrators and custodians to allow them more time to calculate and distribute the minimum required distribution ("MRD"). Under the 2001 regs, one could wait until Dec. 31st before notifying the administrator as to whom was the designated beneficiary ("DB"). This would place the administrator in a difficult situation since they would have to calculate and make the MRD on that same day. Administrators and custodians now have a three-month window to do this. Reg. 1.401(a)(9)-4, A-4.

The new regs also make it clear that you only eliminate Bs. You cannot add Bs after the death of the OP. "(T)he employee's designated beneficiary will be determined based on the beneficiaries designated as of the date of death who remain beneficiaries as of September 30 of the calendar year following the calendar year of the employee's death". Reg. 401(a)(9)-4, A-4(a).

The new regs also make it clear that an estate can never qualify as a DB. Reg. 1.401(a)(9)-4, A-3. With last year's proposed regs, there was some discussion among commentators as to whether a personal representative of an estate could get around this by assigning the interest in a plan or IRA to an individual before December 31st. However, the new regs are quite clear that this cannot be done - see Reg. 1.401(a)(9)-4, A-1. At a recent ALI-ABA teleconference, IRS officials indicated the assignment is permissible but that the non-DB LE will be used, i.e., the 5-year rule or the decedent's remaining LE.

Yet, the new date is probably not a significant change since Sept 30th will always be well past the disclaimer period. (The new regs also make it clear that the 9 month disclaimer period, set forth in IRC sec 2518, will govern. Regs 1.401(a)(9)-4, A-4(a)). But the date will still be important for purposes of cashing out a beneficiary who is a non-DB, such as a charity or an estate.

#3. Who Are DBs When Computing LE?

This is where the new regs get murky. It is a question of contingent Bs versus successor Bs. The regs use these two terms without a great deal of precision. This is going to lead to some confusion. The LE of a contingent B must be considered. The LE of a successor DB will not. For instance, if you have a lifetime income DB and a remainderman (e.g., a QTIP trust), the remainderman must be considered for LE purposes. If, however, the beneficiary form says to X and then to Y, Y's LE will not be considered for LE purposes. The test seems to be that if Y must outlive X, then Y will not be considered. Reg. 1.401(a)(9)-5, A-7. In my opinion, this will be the result even though the beneficiary form will state that Y is the contingent B.

This rule will create problems for any trust named as a B, as discussed below in section #5.

#4. Separate Accounts

You can separate accounts at any time but it will only be effective for MRD purposes if three dates are complied with. Those dates are September 30th, October 31st and December 31st.

Sept 30th - This is the disclosure date when the administrator or custodian must be notified of whom are the Bs. In other words, this establishes the class of beneficiaries who will receive the benefits. Keep in mind that the Bs do not have to actually receive the benefits or have the accounts separated at this time. Rather, the administrator or custodian is simply told who the Bs will be.

There is apparently only one exception to this - if the B is a trust.

Oct 31st - If a trust is named as B, then the trustee must certify the class of Bs to the administrator or custodian by this date. This effectively gives a trust an additional thirty days to comply. The notification can be done by either listing all Bs, including contingent Bs, or by providing a copy of the trust agreement to the administrator or custodian. Reg. 1.401(a)(9)-4, A-6(b).

Dec 31st - This is the separation date. If there are multiple Bs, then separate accounts for each must be established by this date. If so, then each B who is a DB takes over the B's life expectancy. If not separated and all Bs are DBs, then all Bs take over the LE of the oldest B. If there are Bs who are not DBs (e.g., charities or estates), then it will be the five year rule (for death before RBD) or the deceased OP's remaining LE (for death after RBD)

How does Dec 31st jibe with Sept 30th? The administrator or custodian must be told by Sept 30th as to who the Bs will be. But the accounts for each B do not have to be actually separated until Dec 31st .

But what does "separate accounts" actually mean? There will likely be a big debate over this -- whether the new regs require separate accounts or merely separate accountings. The new regs are very poorly drafted on this issue. Reg. 1.401(a)(9)-8, A-3. The regs first talk in terms of allocating investment gains and losses to certain accounts. This sounds like accounting lingo. But then there is mention of "separate accounts (that) are actually established". That sounds like physical separation of accounts. Until some definite guidance is forthcoming, separately titled accounts are the best and safest course of action.

#5. Trusts As DBs - Still Tricky

The biggest disappointment by far in the new regs is the uncertainty created when a trust is named as a beneficiary. The regs are not clear and the commentators are divided over this.

Nothing in the new regs changes the basic requirements regarding when the beneficiary of a trust will qualify as a DB. Reg. 1.401(a)(9)-4, A-5(b). These four requirements, familiar to most practitioners, are:

  1. The trust is valid under state law

  2. The trust is irrevocable at death

  3. The trust Bs are identifiable, and

  4. The trust documentation has been provided to the plan administrator.

The confusion concerns what LE must be used. The easy way is to simply use the LE of the oldest DB. But this may be very disadvantageous if there is a wide age disparity among the DBs. It appears that, with one big exception, we will often be stuck using the LE of the oldest DB. The regs seem to be quite clear that a trust cannot use the separation of accounts to stretch out the LE of younger trust Bs. Reg. 1.401(a)(9)-4, A-5(c)

This inability to separate accounts within the trust is going to cause problems since one must consider all trust Bs when determining LE. Reg. 1.401(a)(9)-5, Q&A 7(c). The emerging consensus among commentators is a "look at the beneficiary form" test. That is, this problem can be lessened or avoided by indicating on the beneficiary form that a particular sub-trust will be the beneficiary. This will then limit the number of Bs whose LE must be considered to the Bs of that particular sub-trust. For instance, the beneficiary form should read something like "To the Surviving Spouse's Trust as established by the Jones Family Trust, uad June 18, 2002". Whether a custodian or plan administrator will accept such a designation is another matter.

The one big exception will be with "conduit" or "pass-through" trusts that mandate that all trust proceeds, or at least the MRD, be distributed to the trust B by year-end. The LE's of any contingent Bs will not be considered for a conduit trust. Reg. 1.401(a)(9)-5, A-7(c) Ex 1 & 2.

Another area of considerable debate concerns the ability of a surviving spouse to rollover the IRA or plan when the surviving spouse is the primary trust beneficiary. Can the spouse "look-through" the trust and roll the proceeds? There is a long line of PLRs that essentially holds that, when the surviving spouse is the personal representative and sole beneficiary of a probate estate, the surviving spouse can "look through" the probate estate and roll the IRA or plan. There is no agreement among the commentators as to whether this concept can be applied to trusts under the new regs.

There are some ways around this problem. A disclaimer can be used if the surviving spouse is named as a contingent beneficiary on the beneficiary form. Or the surviving spouse, in the capacity as trust beneficiary, can receive the funds from the IRA or plan and then do a 60-day rollover with the proceeds (although there may be a problem with the 20% withholding). Or you can revoke the trust prior to the Sept 31st disclosure date.

#6. Default Provisions

If the OP dies after RBD, the default provision is the LE of the DB or the 5-year rule if there is no DB. Reg. 1.401(a)(9)-3, A-4(a).

#7. B Dies After OP's DoD But Before Sept 30th

The problem here is that a B dies before being named a DB (i.e., before Sept 30th). The 2001 regs did not address this and there was considerable concern that B's estate might become the B and thereby lose the use of the deceased B's LE. The new regs make this clear - the LE of the deceased B will be used by the new Bs. Reg. 1.401(a)(9)-4, A-4(c). But there will be a different result if the surviving spouse is the B who dies before Sept 30th - the LE of the surviving spouse's DB will be used. Reg. 1.401(a)(9)-3, A-5 & -4, A-4(b). If there is no DB of the surviving spouse, then the 5 year rule applies.

#8. MRD For OP In Year Of OP's Death

The new regs make it clear that an MRD must be taken for the year in which the OP dies, using OP's LE. Reg. 1.401(a)(9)-5, A-4(a).

#9. MRDs Cannot Be Rolled Over

This has always been the law. IRC sec. 402(c)(4)(B). The new regs on this point are unbelievably dense, obtuse and contorted. I honestly do not understand what the new regs say on this other than that nothing in the new 401(a)(9) regs change anything in the IRC 402(c) regs. Reg. 1.401(a)(9)-7, A-1. See also Reg. 1.401(a)(9)-10, A-4.

When doing a rollover, the new regs give the transferring plan or IRA the right to withhold the MRD for the year and to only transfer the balance. Reg. 1.401(a)(9)-7, A-3(a)

#10. Spousal Rollover Can Be Done At Any Time After OP'S Death

This is expressly stated in the new regs with the condition that the spouse must be the sole B of OP's IRA. Reg. 1.401(a)(9)-10, A-5.

#11. DBs Can Switch To New Regs

This is something to be on the lookout for. For Bs who were stuck with the 5-year default rule, the new regs allow for an election out of the 5-year rule and into the B's LE if the B is a DB. Reg. 1.401(a)(9)-1, A-2(b). The typical scenario in my experience has been that the B was wrongly informed that a 5-year payout was required, even though the B met the requirements of a DB. The DB can now correct this mistake. However, the DB must compute and distribute what would have been distributed had the DB's LE been used from the outset. For instance, if you are in year #5 and the DB has a 25-year LE, then one-fifth (5/25) of the plan or IRA must be distributed.

#12. Older DB Can Use OP's LE

This is a nice feature. If a DB is older than the OP, the new regs allow that B to continue using the LE of the younger OP if the OP died after the required beginning date. Reg. 1.401(a)(9)-5, A-5(a)(1).

#13. Date Of Marital Status Is Set At Jan 1st

A question arose under the 2001 regs as to what LE to use if a married OP died or became divorced during the year. This will be an issue if the surviving spouse is more than ten years younger than the OP and using the Joint Life Table. The new regs allow the surviving spouse to use the joint table for the year of OP's death. In the following year, the Single Life ("Beneficiary") Table must be used.

Likewise, if the OP had to take a MRD in the year of OP's death, then the surviving spouse will have to take that MRD even if the spouse otherwise would not have to take one (e.g., if a younger spouse does a rollover).

#14. Effective Date

The new regs, issued April 16, 2002, must be used to all distributions made on or after January 1, 2003. Reg. 1.401(a)(9)-1, A-2(b). For 2002, you can choose whatever works best - the 1987, 2001 or 2002 regs.

#15. New Reporting Requirements

Beginning in 2003, all administrators and custodians must either determine the OP's MRD and so notify the OP or must offer to make such a determination. Note that this apparently only applies to OPs and not to Bs.

Beginning in 2004, the administrator or custodian must inform the IRS if the OP must receive a MRD but they do not have to compute the amount. Reg. 1.401(a)(9)-10, A-10.

Thomas J. Murphy is an estate planning, elder law and probate attorney practicing in the Ahwatukee section of Phoenix. He can be reached at 480-838-4838 or via email at tjmurphy@primenet.com

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