Guest Article

Update on Required Minimum Distributions

by James E. Hughes

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The IRS recently issued new rules that greatly simplify the process of planning for and calculating Required Minimum Distributions from IRAs and certain employment related retirement plans. This article summarizes the new rules.

Background

Required Minimum Distributions ("RMDs") are the minimum annual withdrawals that must be made from IRAs and certain employment-related retirement plans (called "Tax Deferred Accounts" herein) during an account holder's retirement years. These Tax Deferred Accounts provide tax-free growth as an incentive to save towards retirement. RMDs are imposed so that such funds are used primarily for retirement rather than saving them to be passed to the next generation. Failure to timely make RMDs can trigger an excise tax equal to 50% of the required amount not timely distributed, so RMDs should not be overlooked.

Effective Now For All But First Timers

Account holders who have been doing this the old way can start using the new method right away. There is one exception; account holders who attained age 70-1/2 in 2000 have to use the old method to calculate their 2000 RMDs. For 2001 RMDs, which must be completed by December 31st, 2001, everyone can rely upon the new rules. (A full description of the old method is beyond the scope of this article.)

Overview

The new proposed regulations simplify the rules as follows:

The simplified rules produce smaller required lifetime withdrawals for most people.

• RMDs during the account holder's lifetime can be calculated without regard to the Designated Beneficiary's age (except when required distributions can be further reduced by considering the age of a spouse beneficiary who is more than 10 years younger than the account holder).
• A single table is used to determine RMDs during ones lifetime.
• It is no longer necessary to decide whether or not to recalculate one's life expectancy in determining RMDs.
• It is no longer necessary to satisfy a separate incidental death benefit rule.

There is much greater flexibility in naming designated beneficiaries.

• Post-death RMDs are no longer fixed as of the account holder's required beginning date. For purposes of determining post-death payouts, the beneficiary can now be determined as late as the end of the year following the year of the account holder's death. This allows several additional planning benefits.
• The account holder can change designated beneficiaries after the required beginning date without increasing lifetime RMDs.
• The beneficiaries whose measuring lives are used to calculate RMDs can be changed after the account holder's death by, for example, one or more beneficiaries disclaiming or being cashed out.
• The calculation of post-death minimum distributions can take into account an account holder's remaining life expectancy at the time of death. This allows distributions in all cases to be spread over a number of years after death.

Planning Objective

Withdrawals from Tax Deferred Accounts are taxed as regular income in the year of withdrawal. It is best to minimize withdrawals from Tax Deferred Accounts as long as possible to enjoy tax deferred growth. If the account holder can avoid using tax deferred funds, than only the Required Minimum Distributions need to be withdrawn. One can always withdraw more than the required minimum. However, if more than the minimum is withdrawn in a given year, the excess cannot be applied toward RMDs in future years.

RMDs Under The New Rules

Generally, Required Minimum Distributions must be started by April 1st of the year following the calendar year in which the account holder attains age 70-1/2. If the account is through the account holder's current employer and the account holder does not own 5% or more of the business, the account holder can wait until April 1st of the year following the calendar year he retires, if later. This is called the account holder's Required Beginning Date. Normally, each year's RMD must be completed by December 31st. Only in the first year can an account holder wait until the following April 1st. (Consider this to be a little break, in case you forget to start taking your distributions in the first year.)

Calculating the Required Minimum Distribution

To determine the current year's RMD, the combined total of all Tax Deferred Accounts as of December 31st of the preceding year is divided by the Distribution Period corresponding to the account holder's attained age in the current year. At least this amount must be withdrawn before December 31st of the current year. RMDs can be taken at any time during the year, in one or more withdrawals, so long as at least the RMD amount is withdrawn by year end. Withdrawals from any Tax Deferred Account can be applied toward the account holders combined total minimum distribution requirement for all such accounts.

The Distribution Period is found in the MDIB Table set forth at the end of this article. Each Distribution Period in the table is the joint life expectancy of a person at the indicated age and a second person 10 years younger. The joint life expectancy is the average time before the second of the two people pass away. This is always longer than a single life expectancy. This produces a longer Distribution Period and results in lower RMDs in any given year. Major simplification is achieved by giving everyone the benefit of this longer distribution period. The old rules only allowed use of this longer distribution period if several complex requirements were satisfied. Now, one need only refer to this Table each year to calculate pre-death distributions.

Here's an example regarding attained age using the break one gets in the first year: If the account holder attains age 70-1/2 in 2000 and is doing the calculation in March 2001, he will use the age he attains in 2000 and his December 31, 1999 account balances. He will have to use the old method for his 2000 RMDs that must be completed by April 1st 2001. He can use the new method thereafter.

Here's the Formula:

[Prior year end total of all Tax Deferred Accounts]

Divided by [The number from the MDIB Table based upon attained age in the current year] Equals [The RMD for all Tax Deferred Accounts in the current year].

This process is repeated each year until the account is depleted or death. If the money isn't gone, this process is also repeated for the year of death. For the year after death, the rules are similar to the way they were before.

There's an exception to the new method if the account holder has a spouse who is more than ten years younger. In that event, the old method for calculating joint life expectancy can be employed to produce a longer Distribution Period.

For distributions during one's lifetime, the new method is much easier than the old one. Under the old rules you had to figure out whether or not to use methods involving Joint Lives and Recalculation. You also had several tables to choose from and you had to consider the ages of the beneficiaries you designated on each account. Certain calculations even required using a table backwards. Worst of all, you had to make these decisions before your Required Beginning Date (mentioned above). If you made the wrong choices, you were stuck with an unnecessarily short Distribution Period that could never be lengthened. With few exceptions, the new method gives you the lowest RMD for each year during your lifetime. Other than as a deadline for commencing RMDs, the Required Beginning Date is no longer that important.

After the Account Holder's Death

For years after the year of the account holder's death, the distribution period generally is the remaining life expectancy of the Designated Beneficiary. The beneficiary's remaining life expectancy is calculated using the attained age of the beneficiary in the year following the year of the account holder's death, reduced by one for each subsequent year. The life expectancy of the oldest Designated Beneficiary is still considered with respect to each Tax Deferred Account. One significant improvement has been made. Under the old method, the life expectancy of prior beneficiaries, even if later removed, often had to be considered. Now only those beneficiaries designated on each account that remain as of the end of the year after the year of death need to be considered.

This allows for some planning opportunities. For example, one could designate a spouse as beneficiary and their children as contingent beneficiaries. After death, the spouse might find it advantageous to disclaim the benefit. In such event, the eldest child's life expectancy is used to calculate the RMDs beginning with the year following the year of death. Because the child has a longer life expectancy, the RMDs will thereafter be much lower.

No Beneficiary

If there is no Designated Beneficiary as of the end of the year after the account holder's death, the Distribution Period is the account holder's life expectancy calculated in the year of death, reduced by one for each subsequent year.

Spouse Beneficiary

If the account holder's spouse is the sole beneficiary at the end of the year following the year of death, the distribution period during the spouse's life is the spouse's single life expectancy. For years after the year of the spouse's death, the Distribution Period is the spouse's life expectancy calculated in the year of death, reduced by one for each subsequent year.

Election of Surviving Spouse To Treat An Inherited IRA As The Spouse's Own IRA

As before, an eligible surviving spouse may re-designate the IRA with the name of the surviving spouse as owner rather than beneficiary. In addition, a surviving spouse's election to treat an inherited IRA as the spouse's own will be implied if the surviving spouse contributes to the IRA or does not take the RMD as a beneficiary of the IRA. This deemed election is permitted only after taking the RMD, if required, for the year of the account holder's death. The election is permitted only if the spouse is the sole beneficiary and has an unlimited right to withdraw from the account. This requirement is not satisfied if a trust is named as beneficiary of the IRA, even if the spouse is the sole beneficiary of the trust.

Death Before Required Beginning Date

The former five-year distribution rule that applied in the case of death before the Required Beginning Date with a non-spouse beneficiary is eliminated. Now, for an account holder with a Designated Beneficiary, the same rules apply regardless of whether death occurs before or after the Required Beginning Date. The 5-year rule applies only if the account holder does not have a Designated Beneficiary as of the end of the year following the year of the account holder's death.

In the case of death before the Required Beginning Date, the proposed regulations allow a waiver, unless the IRS determines otherwise, of any excise tax resulting from failure to take RMDs during the first five years after the year of the account holder's death if the entire account is distributed by the end of the fifth year following the year of the account holder's death.

Trust as Beneficiary

As before, the beneficiary of a trust may be a Designated Beneficiary for purposes of determining RMDs when the trust is named as the beneficiary on a Tax Deferred Account, provided the following conditions are met:

• Documentation of the underlying beneficiaries of the trust must be timely provided to the Tax Deferred Account administrator.

• In the case of individual accounts, unless the lifetime distribution period for an account holder is measured by the joint life expectancy of the account holder and the account holder's spouse, the deadline under these proposed regulations for providing the beneficiary documentation is the end of the year after the year of death. This is consistent with the deadline for determining the account holder's Designated Beneficiary.

• The proposed regulations provide examples in which a testamentary trust is named as an account holder's beneficiary and the look-through trust rules apply.

• The examples also clarify that remaindermen of a "QTIP" trust must be taken into account as beneficiaries in determining the Distribution Period for required minimum distributions if amounts are accumulated for their benefit during the life of the income beneficiary under the trust.

Designated Beneficiary

As before, a Designated Beneficiary must be a living person ("must have a pulse"). Except as noted for trusts above, a designated entity other than a living person will result in the Tax Deferred Account being treated as having no Designated Beneficiary.

IRA Reporting of Required Minimum Distributions

IRA providers soon will be required to calculate and report RMD amounts to each IRA owner or beneficiary and to the IRS. This reporting will indicate that the IRA owner is permitted to take the RMD from any other IRA of the owner. The IRS will be developing procedures and a schedule for meeting this requirement.

Amendment of Qualified Plans

For distributions for the 2001 and subsequent calendar years beginning before the effective date of final regulations, qualified plan sponsors are permitted, but not required, to follow the new rules by adopting a model amendment provided in the proposed regulations. Plan sponsors should not adopt other amendments to attempt to conform their plans to the changes before publication of final regulations.

Amendment of IRAs

For distributions for the 2001 calendar year, IRA owners are permitted, but not required, to follow the new rules notwithstanding the terms of the IRA documents. IRA owners may therefore rely on the proposed regulations for distributions for the 2001 calendar year. IRA sponsors should not amend their IRA documents to conform their IRAs to the changes in the proposed regulations before the publication of final regulations.

What Do We Do Now?

Those already taking RMDs should revisit how much they will need to withdraw for 2001 under the new rules and compare that figure to the required payout under the old rules. Those who wind up with a smaller RMD under the new rules and want to take smaller withdrawals should reduce their payouts to conform to the new RMD rules. This will result in a lower tax bill, a longer-lived tax shelter for the family, and potentially larger payouts for the owner's beneficiaries. Similarly situated retirement plan account owners should take the same course of action if their plans allow them to do so.

Minimum Distribution Incidental Benefit (MDIB) Table

The following table is used for determining the distribution period for lifetime distributions to an account holder.

Age of the Account Holder	Distribution Period
70	26.2
71	25.3
72	24.4
73	23.5
74	22.7
75	21.8
76	20.9
77	20.1
78	19.2
79	18.4
80	17.6
81	16.8
82	16.0
83	15.3
84	14.5
85	13.8
86	13.1
87	12.4
88	11.8
89	11.1
90	10.5
91	9.9
92	9.4
93	8.8
94	8.3
95	7.8
96	7.3
97	6.9
98	6.5
99	6.1
100	5.7
101	5.3
102	5.0
103	4.7
104	4.4
105	4.1
106	3.8
107	3.6
108	3.3
109	3.1
110	2.8
111	2.6
112	2.4
113	2.2
114	2.0
115 and older	1.8

Jim Hughes is a partner with the law form of Hancock & Estabrook, LLP, Syracuse, NY, concentrating in Employee Benefits.

Copyright 2001, James E. Hughes

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