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IRA and Pension Distributions: IRS Makes Bold Move in Simplification
Reproduced with permission from CCH Focus published and copyrighted by
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Finally! After more than a decade of confusion and uncertainty, the Internal Revenue Service has taken a bold first step in simplifying the rules that are used to calculate minimum required distributions (MRDs) from traditional individual retirement accounts and other types of retirement plans (e.g., 403(b) plans, 457 plans and corporate qualified plans) and the naming of plan beneficiaries. The revisions were included in a proposal issued on January 17, 2001, and may be relied upon in 2001.
For most individuals, the most important feature of the new rules is that they may significantly increase the time over which their retirement funds must be withdrawn. As a result, the tax deferral advantage on retirement assets has been greatly enhanced. Because this move by the IRS has a significant impact, it must be taken into account by most employers and employees, as well as banks, trusts and other types of companies that sponsor and administer retirement plans. The IRS has announced that the new rules may be used for determining minimum required distributions that are made during 2001.
Determining MRD
Determining an individual's MRD from a traditional IRA and most other types of retirement plans is made much simpler under the new proposed regulations. This is because the IRS has now endorsed the use of one life expectancy table that individuals may use when calculating their yearly MRDs. Use of this single table eliminates some of the complicated options that existed under the prior proposed regulations.
As a starting point in applying the MRD rules, it is important to remember that, for most employees, the rules only come into play when the individual has reached age 70 1/2 or has retired, whichever is later. (For 5% owners, or owners of IRAs, only the 70 1/2 rule applies.) In most situations, distributions made before age 70 1/2 are not subject to statutory minimums. The fundamental rule for most distributions requires that the individual:
receive a total distribution no later than the required beginning date (e.g., April 1 of the year following the year in which the individual reached age 70 1/2), or
start to receive distributions, beginning no later than the required beginning date,
(a) over the life of the individual,
(b) over the lives of the individual and a designated beneficiary,
(c) over a period not extending beyond the life expectancy of the individual, or
(d) over the life expectancy of such employee and a designated beneficiary.
Under the proposal, different rules determine the MRDs that start before the individual's death and those that are required to be made when the individual has died before the required beginning date.
MRDS before Death
When distributions are being made from a defined contribution plan, including a non-annuity traditional IRA, the new proposed regulations provide that the MRD for each distribution year is determined by dividing the account balance by the "applicable distribution period." The account balance is determined as of the last business day in the year prior to the year of distribution. The "applicable distribution period" is generally determined by the life expectancy table contained in the new proposed regulations.
Example 1
Mark Knopfler was born on October 1, 1931. He reaches age 70 1/2 in 2002. Mark is not married and had been a participant in his employer's defined contribution plan until he retired. His required beginning date for purposes of calculating the MRD is April 1, 2003. The calendar year for which a MRD must be made is called a "distribution calendar year." If an individual's required beginning date is April 1 of the year following the year in which the individual reaches age 70 1/2, the first distribution calendar year is the year in which the individual attains age 70 1/2. If an individual's required beginning date is April 1 of the year following retirement, the year of retirement is the individual's first distribution year. As of the last applicable valuation date (i.e., December 31, 2001, the year prior to the year of distribution), Mark's balance in the plan was $25,300. This amount is the figure used as part of the formula in determining the required MRD.
Example 2
Assume the same facts as in Example 1, above. In determining the applicable distribution period for his first MRD, Mark would use the life expectancy table in the proposed regulation. Mark's age on his birthday in the distribution year (i.e., 2003) will be 71. According to the table, the distribution period at age 71 is 25.3 years. Thus, the minimum MRD for 2002 (the year he reaches age 70 1/2) is $1,000 ($25,300 divided by 25.3 years). The MRD of $1,000 must be distributed to Mark by April 1, 2003.
The life expectancy table contained in the new proposed regulations has substantially lengthened the period over which MRDs are to be made. For example, under the "single life expectancy table" contained in the prior proposed regulations, at age 79, an individual's life expectancy was 10 years. Under the new table, at age 79, an individual may calculate the MRD by using a period of 18.4 years.
Although the life expectancy table in the new proposed regulations is to be used to calculate MRDs in most situations, there is an important exception. When the individual's sole beneficiary is the individual's spouse, and the spouse is more than 10 years younger than the individual, then the MRDs made during the individual's life are calculated based upon a distribution period that is the longer of (a) the period determined under the general rule, as set forth above, or (b) the joint life and last survivor life expectancy of the individual and spouse. Different calculations must be used to determine annuity distributions from defined benefit plans.
When a surviving spouse is named as a beneficiary of plan assets, another possible way to extend the period of time over which MRDs must be made would be to roll over the inherited assets into the spouse's own IRA. When this is done, the MRD is determined by viewing the surviving spouse as the owner of the assets and not as the beneficiary of the deceased individual. In order to use this rollover option, the spouse must be named as the sole beneficiary of the plan assets and have an unlimited right of withdrawal. The rollover option does not exist if a trust is named as the beneficiary of the assets, even if the spouse is the sole beneficiary of the trust.
MRDS after Death
After an individual's death, the period over which distributions must be made depends upon whether death has occurred on or after the required beginning date, or before the required beginning date.
Death on or After Required Beginning Date
In this situation, the applicable distribution period for calendar years after the year of death is either:
the remaining life expectancy of the individual's designated beneficiary, or
the remaining life expectancy of the individual, if the individual does not have a designated beneficiary.
Death Before Required Beginning Date
When an employee dies before required distributions have begun, the applicable distribution period is generally the remaining life expectancy of the designated beneficiary. The determination of life expectancy depends upon whether the beneficiary is the individual's spouse or another individual. If there is no designated beneficiary, then applicable distribution period is determined by the life expectancy of the individual, using the individual's age as of the birthday in the year of death. In subsequent years, the applicable distribution period is reduced by one for each year that has elapsed since the year of death.
Naming a Beneficiary
The proposed regulations remove the burden that required that an individual designate a plan beneficiary by the required beginning date or date of death. Under the new rules, the designated beneficiary may be determined as of the end of the year following the year of death. Therefore, any beneficiary eliminated by distribution of the benefit or through disclaimer during the period between the individual's death and the end of the year following the year of death is disregarded in determining the designated beneficiary for purposes of calculating required minimum distributions. If, as of the end of the year following the year of death, there is more than one designated beneficiary and the assets have not been divided into separate accounts or shares for each beneficiary, the beneficiary with the shortest life expectancy is the designated beneficiary.
IRA Reporting Requirements and Penalties
According to the IRS, due to the fact that these proposed regulations substantially simplify the calculation of MRDs from IRAs, IRA trustees determining the account balance as of the end of the year can also calculate the following year's MRD for each IRA. Therefore, in order to improve compliance and further reduce the burden imposed on IRA owners and beneficiaries, the proposed regulations require the trustee of each IRA to report the amount of the required minimum distribution from the IRA to the IRA owner or beneficiary and to the IRS. The IRS will spell out the reporting details at a later date. This reporting will be required regardless of whether the IRA owner is planning to take the required minimum distribution from that IRA or from another IRA and would indicate that the IRA owner is permitted to take the required minimum distribution from any other IRA of the owner. The reporting requirements will probably go into effect for 2002. The IRS is also considering whether similar reporting requirements would be appropriate for Code Sec. 403(b) contracts.
The IRS has reemphasized the fact that a 50-percent penalty may be charged on the amount of the MRD that was not distributed. In the past, this penalty was largely ignored by the IRS because it had no easy way to determine what MRD should have been made to a particular individual. However, if IRA trustees become subject to MRD reporting, it will be easier for the IRS to enforce the penalty. The penalty may be waived if the individual can show reasonable cause.
Regs Are Valid for 2001
Even though these regulations are only proposed to go into effect for calendar years beginning on or after January 1, 2002, they may be used to determine MRDs for calendar year 2001. Thus, for 2001, when computing their MRDs, individuals have the option of using the proposed regulations that were issued in 1987 or the proposed regulations that were released in January 2001. The IRS notes that if future regulations are more restrictive than the 2001 proposals, the restrictions will not impact the calculations made for 2001.
Source: Neil A. Ringquist, C.P.A., J.D., Senior Writer Analyst, CCH FEDERAL TAX GUIDE AND CCH U.S. MASTER TAX GUIDE. CCH FEDERAL TAX GUIDE explains federal income, estate and gift, payroll and selected excise taxes. CCH analysis clearly covers all the rules relating to the tax issues most important to you and your clients - individuals, small businesses, estates and trusts - while pointing out tax savings and tax planning opportunities. The Federal Tax Guide is available on the Internet, as a monthly CD-ROM, or as a looseleaf print service. For more information, call 1-800-449-8114.
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