2001 Lane Reports

New Proposed Regulations Make IRA Planning Simpler

Friday, June 1, 2001
by Joshua S. Kreitzer, J.D.

It may seem hard to believe, but new regulations proposed by the Internal Revenue Service are already making life simpler for investors and retirees. Beginning in 2001, many participants in retirement plans and owners of individual retirement accounts (IRAs) can reduce their minimum required distributions from their accounts.

A little background is in order. After reaching age 70˝, retirement plan and IRA account holders are required to take at least a minimum distribution from their accounts each year. (Specifically, the first distribution must be taken by the "required beginning date" — April 1 of the calendar year after the calendar year in which the account holder turns age 70˝. Succeeding distributions must be taken by December 31 of that year and each year following.) The minimum required distribution must be calculated for each IRA owned (and qualified plan participated in) by the same individual, but these amounts must be totaled and the total distribution may be taken from any one or more of the individual's IRAs. For account holders who don't need money from their plan or IRA for current income, it's best if they take as small a distribution as possible, for two reasons: (1) they are taxed on distributions they received from their plan or IRA, and (2) the money allowed to stay in the account can continue to grow tax-deferred. Those who do need the money can always take more than the minimum required distribution.

Until this year, just determining the minimum amount the account holder was required to distribute was a complex process, requiring account holders (or their financial planners) to consult one of three tables found in Treasury regulations, depending in part on who the account holder's beneficiary was. Account holders were required to select the beneficiary of their plan account or IRA before taking their first required distribution at age 70˝. The tables themselves were based on the account holder's age (and, in some cases, the beneficiary's age as well). As account holders grew older, the larger a fraction of their accounts would be required to be distributed. The penalty for failing to meet the required distribution rules is an excise tax of 50% of the difference between the amount actually distributed and the required distribution. The former rules were so complex that any taxpayers could be in violation without knowing it.

Many aspects of these rules have changed under the new proposed regulations, including the following:

  • Almost all account holders will use one table to calculate their minimum required distribution, and this table allows a longer distribution period than the tables many account holders were required to use under the prior rules. This means that minimum required distributions will be reduced for many account holders. The only exception to the use of this table applies if the beneficiary is the account holder's spouse who is at least 10 years younger than the account holder — and in that case, an even more favorable table is used.

  • The beneficiary of a plan or IRA no longer needs to be selected when the account holder reaches age 70˝; in fact, the designated beneficiary, for purposes of calculating distributions after the account holder's death, will be determined based on the persons who are beneficiaries as of December 31 of the year following the year of the account holder's death. (A "designated beneficiary" must be an identifiable individual; an estate or a charity will not be considered a "designated beneficiary.") This is significant because proper selection of a designated beneficiary can enable the IRA to exist (and grow tax-deferred) for years after the account holder's death; under the new regulations, beneficiaries who cannot be "designated beneficiaries" may be cashed out before December 31 of the year after the account holder's death. Hence the new proposed regulations allow some opportunity for the executor of an estate to make decisions which will enable the IRA to be used to the beneficiaries' best advantage.

For distributions in years after the account holder's death, the required minimum distribution depends on whether the account holder died before or after reaching his or her required beginning date and whether the IRA has a designated beneficiary. If there is a designated beneficiary, the required minimum distributions after the account holder's death will be based on the life expectancy of the designated beneficiary (regardless of the account holder's age at death). If there is no designated beneficiary — for example, if the account holder's estate is the only beneficiary of an IRA — the account must be completely distributed within five years of the account holder's death if the account holder died before reaching age 70˝. If the account holder has no designated beneficiary but dies after the required beginning date, such distributions are made according to the account holder's life expectancy as of the year of the account holder's death, reduced by one year each year after the account holder's death. For example, if an account holder dies during the year that he turns 80 (or would have turned 80) and has no designated beneficiary, his life expectancy for minimum distribution purposes is 17.6 years. The distributions for the succeeding years would be based on life expectancies of 16.6 years, 15.6 years, and so on.

Fortunately, the IRS has not made any substantial changes to a favorable set of provisions which existed under the old regulations. If an individual was an IRA owner at the time of the individual's death, the individual's surviving spouse may elect to treat the deceased spouse's interest in the IRA as a beneficiary as the surviving spouse's own IRA ("Surviving Spousal IRA"). By making this election, the surviving spouse's interest will be subject to the distribution requirements applicable to the surviving spouse as the IRA owner rather than the distribution requirements applicable to a beneficiary. Such an election could be useful if the surviving spouse is younger than the deceased spouse and wants to let the IRA's assets continue to grow tax-deferred.

However, if the surviving spouse is under age 59˝, it's often undesirable for the surviving spouse to treat the deceased spouse's IRA as his or her own; if the surviving spouse treats the deceased spouse's IRA as his or her own, an additional 10% tax is imposed on any distributions made before the surviving spouse reaches 59˝. By contrast, if the IRA continues to be an IRA of the deceased spouse of which the surviving spouse is merely a beneficiary ("Spousal Beneficiary IRA"), the surviving spouse may take distributions at any time without being subject to the 10% penalty. On the other hand, in such a case, minimum required distributions are then governed by the deceased spouse's age. Consequently, a surviving spouse should take care in deciding whether or not to elect to treat the deceased spouse's IRA as his or her own.

Under the new proposed regulations, the election to make the deceased spouse's IRA a Surviving Spousal IRA is made by the surviving spouse redesignating the account in the surviving spouse's own name as IRA owner rather than as the beneficiary. However, the surviving spouse will also be deemed to have made such an election if (1) distributions from the deceased spouse's IRA are not made within the appropriate time period applicable to the surviving spouse as beneficiary, or (2) any additional amounts are contributed to the account.

Note that a rollover of a distribution from a qualified plan in which the deceased spouse was a participant to the deceased spouse's IRA is not considered an additional contribution; if the surviving spouse has such a distribution rolled over, the surviving spouse still has the option to elect whether to treat the deceased spouse's IRA as a Surviving Spousal IRA. That is, rolling over the deceased spouse's qualified plan money is not in itself an election to treat the Spousal Beneficiary IRA as the surviving spouse's own IRA.

One aspect of the new regulations will give the IRS additional opportunity to monitor compliance with the minimum required distribution rules. Previously, the custodian of an IRA was required to report to the IRS the amount actually distributed to each account holder each year. However, the IRS was not informed of the amount of each account holder's required minimum distribution; consequently, the IRS was rarely able to enforce the distribution requirement and 50% penalty. Now that the calculation of the minimum required distribution has been simplified, however, the custodians of an IRA must also report to the IRS the account holder's minimum required distribution for each year. The IRS has not yet announced how or when the custodian must comply with this reporting requirement.

Although these new regulations are "proposed" rather than final regulations, the IRS has authorized taxpayers to calculate their required minimum distributions according to the new proposed regulations beginning immediately. (In fact, the former regulations never became final; like the new regulations, they were put into effect, but they remained at the "proposed" stage for almost fourteen years.)

While account holders remain free to leave their choices of beneficiaries for their IRAs in place under the new regulations, it's a good idea to consult a financial adviser to see if the new proposed regulations present better opportunities for distributing one's IRA.

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The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright, 2003 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.

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