The CPA Journal

IRS Simplifies and Slows IRA Distributions

By Myron S. Blatt, CPA, affiliated with Lockwood Pension Services, Inc.

The IRS has issued new proposed regulations effective in 2001 that radically change the distribution and beneficiary rules for IRAs. The new regulations provide for slower, and therefore lower, required distributions and allow the changing of beneficiaries up to and even after the death of the IRA owner without any impact on the rate of post-death distributions. They are intended to address the confusion and concerns created by the old proposed regulations that were issued as a result of the Tax Act of 1987 but never finalized. Comments regarding the old regulations questioned default provisions, election requirements, plan language requirements, the need for permanent decisions to be made at age 70Qs, and the complex rules governing required distributions.

The new proposed regulations make it much easier for IRA owners, their heirs, and plan administrators to understand and apply the rules for required minimum distributions. They also add significant flexibility in the determination of a designated beneficiary for distributions after the IRA owner’s death.

Examining the Regulations

The following are excerpts from the IRS proposed regulations and a summary of their impact:

Provide a simple, uniform table that all employees (IRA owners) can use to determine the minimum distribution required during their lifetime. This makes it far easier to calculate the required minimum distributions because employees would no longer need to determine their beneficiary by their required beginning date, no longer need to decide whether or not to recalculate their life expectancy each year in determining required minimum distributions, and no longer need to satisfy a separate incidental death benefit rule.

The table selected was called the minimum distribution incidental benefit (MDIB) table (see IRS Publication 590) under the old regulations. The table uses a maximum age difference of 10 years between the IRA owner and the beneficiary, which produces a starting joint life expectancy of 26.2 years when the IRA owner is 70 years old. The MDIB table uses a double recalculation method to determine life expectancy that produces a very long joint life expectancy and therefore low minimum distribution requirements during the IRA owner’s lifetime. Using the MDIB table increases the odds that the IRA will leave a substantial balance to be passed down to heirs.

Permit the required minimum distribution during the employee’s lifetime to be calculated without regard to the beneficiary’s age (except when required distributions can be reduced by taking into account the age of a beneficiary who is a spouse more than ten years younger than the employee).

The only way to use a longer joint life expectancy than the MDIB table is if the beneficiary spouse is more than 10 years younger than the IRA owner (also true under the old regulations). A spouse is still able to roll an IRA over to a new IRA under her own name after the IRA owner’s death.

[Permit]a beneficiary to be determined as late as the end of the (calendar) year following the year of the employee’s death. This allows the employee to change the designated beneficiaries after the required beginning date without increasing the required minimum distribution and the beneficiary to be changed after the employee’s death such as one or more of the beneficiaries disclaiming or being cashed out.

This provision will allow the utmost flexibility in selecting and changing a beneficiary as circumstances change during the life of the IRA owner without changing the rate of distribution or affecting distributions after the IRA owner’s death. In addition, after the IRA owner’s death, a single IRA could be split into several IRAs for multiple beneficiaries, each using a different life expectancy. One of those beneficiaries could be a charity, which could simply cash out its share. This would not affect any other beneficiary nor the amount required to be withdrawn during the life of the IRA owner. Thus, one IRA could suffice where once many were needed.

[Permit] the calculation of post-death minimum distributions to take into account an employee’s remaining life expectancy at the time of death, thus allowing distributions in all cases to be spread over a number of years after death.

Under the previous regulations, when a recalculation method was used and there was no designated beneficiary prior to the required beginning date, the life expectancy of the IRA owner became zero upon death. Now there will be a continuance of distributions depending upon the age of the IRA owner at death.

A frequently heard complaint about IRAs and other deferred tax vehicles is that all withdrawals are taxed at ordinary income tax rates (as high as 39.6% at the federal level, not including the loss of itemized deductions or other hidden penalties). While it is true all withdrawals from an IRA are taxed at ordinary income tax rates (except for Roth IRAs), exactly when required withdrawals outpace the annual increase in the value of the IRA varies from individual to individual. With proper planning, and use of the slower distributions allowed under the new regulations, the required distributions can be further minimized and, therefore, it is more likely that a substantial portion of the IRA can be distributed long after the death of the IRA owner.

Example

Consider the following fact pattern, in which there is no current need for withdrawals and all withdrawals are made only when required:

Current Date: 1/1/01

Amount of IRA: $1,000,000

IRA growth rate: 10%

IRA owner’s date of birth: 1/1/31

Spouse’s (IRA beneficiary) date of birth: 1/1/33

Joint life expectancy of owner and spouse starts at 26.2 years under the MDIB Table

Child’s date of birth: 1/1/61.

Grandchild’s date of birth: 1/1/91.

When distributions begin in 2001, the IRA has a value of $1,000,000. The distributions are based upon the MDIB Table (the joint life expectancy starts at 26.2 years and double recalculation is used). The IRA has actually grown to $2,097,868 when the spouse inherits it in 2016 when the IRA owner dies, despite distributions totaling $1,330,411

The spouse inherits the IRA, creates a spousal rollover IRA, names the child and grandchild as beneficiaries, and begins distributions in 2017. When the spouse dies in 2023, $1,289,679 has been withdrawn in 7 years and $2,389,197 is left in the IRA.

Upon the spouse’s death, the IRA is split: The child inherits an IRA of $1,389,197 and the grandchild inherits an IRA of $1,000,000. The child makes required distributions over a period of 21.6 years and the grandchild makes required distributions over a period of 49.3 years. In the 22 years between 2024 and 2045, the child and grandchild make distributions totaling $6,607,164.

When the grandchild completes her 49.3-year period of withdrawals (2046–2073), she has received an additional $25,654,965 (for a total of $27,150,673). The majority (73.55%) of the total distributions occur during this period 30 and 57 years after the IRA owner’s death. Furthermore, nearly half (49.5%) of the total distributions—$17,280,015—occurs during the last 10 years of this period, 48 and 57 years after the IRA owner’s death. Although there is an ordinary income tax on IRA distributions, a majority of that tax bill could actually be payable half a century after the IRA owner’s death. Most of the time during which the required distributions are being made, the IRA is still growing, providing a long-term deferred tax vehicle for the IRA owner and heirs.

Editor:
Susan R. Schoenfeld, JD, LLM, CPA
Bessemer Trust company, N.A.

Contributing Editor:
Jerome Landau, CPA

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Current Date:	1/1/01
Amount of IRA:	$1,000,000
IRA growth rate:	10%
IRA owner’s date of birth:	1/1/31
Spouse’s (IRA beneficiary) date of birth:	1/1/33

Child’s date of birth:	1/1/61.
Grandchild’s date of birth:	1/1/91.

IRA PLANNING