By Jack Angel

The rules covering required minimum distributions (RMD) for IRA, 403(b), 401(k), and other qualified plans have become complex and inconsistent over time. In April 2002, the IRS released final regulations that simplify the rules for RMDs. These new rules permit slower distributions, thereby opening the way for greater wealth accumulation and lower current taxes. The new rules will generally appeal to individuals that do not need to withdraw IRA funds for living expenses.

Starting Date

The rules relating to when RMDs must begin have not changed, and severe penalties for failing to take timely RMDs are still in place. The first RMD remains in the year when the owner becomes 70 1/2, and its amount is based upon the value of all IRAs as of December 31 of the year following the calendar year in which the owner turns 70 1/2.

Example. An IRA owner turns 70 1/2 in 2002. The first RMD is based upon the value of the IRA at December 31, 2001.

Normally, an RMD for any year must be taken by December 31 of that year. A one-time deferral of the first RMD is permitted, however, until April 1 of the year following the year the owner turns 70 1/2, referred to as the required beginning date (RBD). If this option is elected, the owner would take and report two RMDs in 2003. The 2003 RMD that must be taken by December 31, 2003, would be based upon the value of the IRA account at December 31, 2002, reduced by the 2002 RMD.

RMD Calculation During Lifetime

The new rules greatly simplify the calculation required to determine the amount of the RMD for any year while the owner is alive.

The calculation requires that the IRA account balance at December 31 of the preceding year be divided by the applicable divisor found in the Uniform Lifetime Table. This new table is based upon the joint life expectancy of an individual and a hypothetical beneficiary 10 years younger, and provides a slower payout than previously without regard to a named beneficiary or the named beneficiary’s age. The Uniform Life Table redetermines the divisor each year.

The only exception occurs when the named beneficiary is an owner’s spouse and is more than 10 years younger than the owner. In that case, the owner may use the more favorable new Joint and Last Survivor Table, based upon the life expectancy of the owner and spouse, and redetermined each year.

RMD Calculation upon Death

When the owner dies, the RMD rules depend on whether the IRA owner had identified a designated beneficiary. A beneficiary can be any entity or person, whereas a designated beneficiary is an individual with a determinable life expectancy, including beneficiaries of qualifying trusts. Estates and charities cannot be designated beneficiaries.

No designated beneficiary. If there is no designated beneficiary and the owner dies after the RBD, the distribution period is the owner’s life expectancy calculated in the year of death, reduced by one each year.

If there is no designated beneficiary, and the owner dies before the RBD, the account balance must be paid out by the end of the fifth year following the owner’s year of death (this can be done all at once at the end of the fifth year).

Designated beneficiary. If the decedent has selected a designated beneficiary, the RMD rules differ for a spouse and non-spouses.

If an IRA has a non-spouse designated beneficiary, the balance is paid out over the remaining life expectancy of the beneficiary using the Single Life Table. The beneficiary’s age and applicable divisor are determined in the year following the year of the owner’s death and reduced by one each year. If the non-spouse designated beneficiaries die with a balance in the IRA, it is paid out over a period not to extend beyond their remaining life expectancy.

When the designated beneficiary is the IRA owners’ spouse, the surviving spouse may take RMDs over the spouse’s single life expectancy (Single Life Table) using the surviving spouse’s attained age in each distribution year (whereas non-spouse beneficiaries take payouts over their life expectancies determined once in the first year, reduced by one each year). After the surviving spouse’s death, the distribution period is the spouse’s life expectancy calculated in the year of that spouse’s death, reduced by one each year.

A non-spouse beneficiary must take the first RMD no later than December 31 following the year of the owner’s death. A designated spouse beneficiary must take the first RMD no later than either December 31 following the year of the owner’s death or December 31 of the calendar year in which the owner would have turned 70 As.

Designated beneficiaries determined upon owner’s death. An IRA passes to beneficiaries without regard to contrary provisions in the decedent’s will, and irrespective of state laws of intestacy if the decedent died without leaving a will.

The new rules specify that designated beneficiaries are 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 account owner’s death, the beneficiary determination date. If there is more than one designated beneficiary and the account has not been timely divided into separate accounts by December 31 following the year of the owner’s death, the beneficiary with the shortest life expectancy is considered the designated beneficiary. If this beneficiary is not an individual or valid trust, the account is treated as not having a beneficiary.

This provision is a change from prior regulations and permits significant postmortem financial and estate planning. For example, if the beneficiaries of an IRA are an individual and a charity, the charity’s share can be paid out by September 30 following the calendar year of the owner’s death, leaving the named individual as a designated beneficiary for RMD purposes.

Furthermore, while beneficiaries named as of the owner’s date of death may be eliminated before the beneficiary determination date (September 30), beneficiaries cannot be added or changed (TD 8987). The regulations also provide that if a designated beneficiary dies between the owner’s death and the beneficiary determination date and if the owner did not designate a contingent beneficiary, the original designated beneficiary continues as the designated beneficiary for purposes of determining the distribution period rather than any successor beneficiary of the deceased beneficiary.

The regulations further clarify that a beneficiary’s disclaimer must satisfy the provisions of IRC section 2518. If a wealthy named beneficiary makes a timely disclaimer of an interest in an IRA (after the owner’s death but before the beneficiary determination date), the IRA passes on as if that beneficiary predeceased the death of the owner.

Separate accounts. Other important planning steps might be taken during the period between the owner’s date of death and December 31 of the following year, particularly when multiple beneficiaries are named in an IRA:

Relief Provisions and Effective Date

The new regulations provide relief to beneficiaries subject to the five-year default rule under the 1987 proposed regulations. Under the old rules, if a plan or IRA was silent about the application of the five-year rule or the lifetime payout rule, the five-year rule was chosen by default. Such beneficiaries may now switch to the life expectancy rule, provided that all accounts that would have been required to be distributed under that rule are distributed by the earlier of December 31, 2003, or the end of the applicable five-year period.

Although the new rules apply for determining RMDs for 2003 and later, specific provision is made in TD 8987 that taxpayers may adopt the new rules to determine RMDs for 2002, even if the taxpayer (or the beneficiary of a deceased owner) began taking mandatory withdrawals before 2002.

©2002 CPA Journal. Legal Notices