The following article is available on the NewRMD.Com Web Site:
by Greg Reymann, J.D., LL.M (Tax), LL.M. (Estate Planning)
Vero Beach, Florida; firstname.lastname@example.org
Copyright © 2001, Greg Reymann. All Rights Reserved.
A. History. On January 11th of this year the Treasury Department (IRS) issued new proposed regulations under Internal Revenue Code (IRC) Section 401(a)(9). The purpose of IRC Section 401(a)(9) is to force distributions from IRAs and retirement plans, which Congress feels is appropriate given that the benefit of tax deferral was granted for the express purpose of encouraging retirement savings. Regulations under IRC Section 401(a)(9) were first proposed on July 27, 1987, shortly before my stint at the IRS in my prior life, and were slightly amended on December 30, 1997, to create new rules for trusts. Two sets of IRS notices have also clarified issues: the first in 1988 (Notice 88-38) permitting the required minimum distributions amount to be taken from the IRA of the IRA owner’s choice; and in 1996 and 1997 (IRS Notices 96-67 and 97-75) regarding changes affecting those still employed at work at age 70½. Other than these minor changes, nothing was done about the 1987 proposed regulations for almost 14 years, which is amazing even for government.
The new proposed regulations may have been worth the wait. In short, they create two ways of calculating required minimum distributions (RMDs) at one’s required beginning date (RBD), regardless of whether the IRA owner has named a beneficiary or who that beneficiary may be. In addition, the rules for calculating RMDs after the IRA owner has died are greatly simplified.
The IRS has scheduled a public hearing on the new proposed regulations (the "New Rules") for June 1, 2001, and hopefully will issue final regulations later in the year. For calendar year 2001 RMDs, IRA owners may either continue to use the distribution rules established in 1987 (the "Old Rules") or the New Rules. Beginning in 2002, however, all IRA owners must comply with the New Rules.
MORATORIUM ON REGULATIONS? On January 24, 2001 the Bush Administration placed a 60-day moratorium on certain regulations. When this moratorium was first issued, most felt that it prevented the new proposed regulations from being effective immediately, for at least 60 days. However, now the majority opinion is that this moratorium does not affect the ability of taxpayers to rely on the new proposed regulations. Note that the moratorium only delayed, for 60 days, a rule’s effective date. These new proposed regulations have an effective date next year (January 1, 2002), not this year, although the regulations indicate that you can rely on them now. Accordingly, it appears that the moratorium has no effect on whether you can rely on the new proposed regulations at this time. This view was recently expressed by Marjorie Hoffman, co-author of the regulations, at a meeting with representatives of the mutual fund industry.
ONE OTHER THING – IT’S RMD, NOT MRD: After the 1987 proposed regulations were issued, it was generally accepted that the age 70½ distributions were called "required minimum distributions," or "RMDs." Somewhere in between 1987 and 2001, people starting calling the age 70½ distributions MRDs, which is an acronym for "minimum required distributions." The battle between RMDs v. MRDs got ugly, but it looks like it has been resolved. The new proposed regulations start off this way: "This document contains proposed regulations relating to required minimum distributions (emphasis added)…". RMD wins.
B. Concerns. The following are some reasons why the IRS was so generous with their New Rules.
1. Outliving the RMD payments. Under the Old Rules, it was possible to outlive one’s IRA. Since estate planners tend to be more concerned about the well being of the little goobers than of the living IRA owner, the general recommendation is to have the widow(er) IRA owner elect the non-recalculation life expectancy method. Under this method, if the widow(er) IRA owner dies with a remaining life expectancy, the little goobers could continue taking payments under the IRA based on the remaining life expectancy. All well and good for the little goobers, but if the IRA owner outlives the non-recalculated life expectancy, the IRA is gone. So, the IRS was rightly concerned that some IRA owners may be outliving their IRA payments.
2. IRA Cashouts. On the flipside, there was also a concern that IRAs were being cashed out. This could occur when the IRA owner choose the recalculation method of determining life expectancy; at his or her death, the life expectancy is reduced to zero, meaning that the IRA must be distributed in the next calendar year following the year of death.
3. Complexity. "You should consider the recalculated method of computing your life expectancy, and the non-recalculated method of computing life expectancy for your surviving spouse, or maybe the recalculated method for your spouse, which you can do for spouses, but for your kid you have to use non-recalculation, or the hybrid method, although this is restricted under the minimum death incidental benefit rules, except at your death, when he or she can use his own life expectancy, but on a non-recalculated basis." This was a good reason to "check out" before age 70½.
4. Congressional Involvement. Proposed legislation last year introduced a one-year window wherein IRA owners could change their beneficiary designation and decisions regarding life expectancy calculations. This would have been messy, from an administrative viewpoint, so the New Rules prevent congressional involvement in this manner.
II. Death before RBD (Old Rules still apply). Before we get to the New Rules, it is necessary to cover the Old Rules. The Old Rules will apply when the IRA owner dies before age 70½. The concepts do not disappear. The Old Rules are as follows:
A. 5-Year Payout. The IRA must be distributed to the beneficiary no later than the December 31st of the fifth year following the IRA owner’s death.
B. Life Expectancy Payments. In the alternative, payments can be made to the beneficiary over his or her life expectancy. These payments must begin no later than the December 31st of the year following the IRA owner’s death. Payments will be non-recalculated, that is, reduced by one each year, unless the beneficiary is the surviving spouse, in which case either method of calculation (recalculation or non-recalculation) can be used.
NOTE: Under the New Rules, the default in case of death before the RBD is the life expectancy method when there is a designated beneficiary (under the Old Rules, the default was the 5-year payout).
C. Surviving Spouse Options. A surviving spouse beneficiary has the 5-year payout options, plus two additional options:
1) he or she can leave the IRA as is (sometimes referred to as a "deceased IRA") and start taking RMDs when the deceased IRA owner would have reached age 70½; or
2) he or she can roll the IRA over into his or her own IRA, then start taking RMDs when he or she reaches age 70½.
III. Summary of New Rules at RBD
A. General Rule. Under the New Rules, reaching age 70½ is no longer a traumatic event; now, with one exception, the required minimum distributions are automatically computed based on the life expectancy figures from the following table:
Age Life Expectancy
Life Expectancy Divisor
70 26.2 85 13.8
71 25.3 86 13.1
72 24.4 87 12.4
73 23.5 88 11.8
74 22.7 89 11.1
75 21.8 90 10.5
76 20.9 91 9.9
77 20.1 92 9.4
78 19.2 93 8.8
79 18.4 94 8.3
80 17.6 95 7.8
81 16.8 96 7.3
82 16.0 97 6.9
83 15.3 98 6.5
84 14.5 99 6.1
And so on up to age 115. This table satisfies one of the concerns with the Old Rules: that it was possible for IRA owners to outlive their IRA (especially under the non-recalculation method which many estate planners routinely recommend). So, that problem will no longer exist, unless the biotech industry keeps people alive until age 130.
The above table, for those familiar with RMDs, is the minimum death incidental benefit (MDIB) life expectancy table, which is the joint life expectancy of the IRA owner and a hypothetical individual whose age is ten years younger than the IRA owner.
This life expectancy table is used regardless of whether or not the IRA owner has designated a beneficiary, and regardless of the health of the IRA owner. Each year, the life expectancy divisor is used, so in effect RMDs are recalculated each year.
EXAMPLE: In 2001, Mr. Watson turns age 70½ and decides to start his required minimum distributions. Being unmarried, he does not designate a beneficiary to his IRA. His IRA was worth $100,000 at the end of 2000. Despite the fact that Mr. Watson has no beneficiary, his RMDs will be based on the MDIB joint life expectancy table, and therefore his RMD amount for 2001 is $3,817 ($100,000 divided by 26.2).
In the year 2002, with a 2001 year-end value of $120,000, Mr. Watson’s RMD amount is $4,724 ($120,000 divided by 25.4).
Note that the New Rules did not change the timing requirement of when distributions had to begin. RMDs have to be made by April 1 of the year following the calendar year when the IRA owner turns age 70½. Of course, if the IRA owner waits until April 1 of the next year to take the 70½ year distributions, two years’ worth of distributions will have to be made that year.
B. The Michael Douglas Exception. An exception exists for IRA owners whose sole beneficiary is a spouse who is younger by a difference of more than 10 years. These IRA owners may still choose to calculate RMDs based on their joint life expectancies with their spouses and in so doing will obtain a lower RMD than is available based on the MDIB table.
IV. Summary of New Rules at death after RBD
A. Death with Designated Beneficiary
1. Nonspousal Designated Beneficiary. After an IRA owner dies, RMDs to designated beneficiaries will be based upon the beneficiary’s individual life expectancy, starting no later than the December 31st of the year following the year of death. Each RMD thereafter is based on the beneficiary’s life expectancy reduced by one.
PRACTICE POINT: Make sure the designated beneficiary is able to designate an individual to receive the remaining lifetime payments after his or her death.
2. Spousal Designated Beneficiary. If the designated beneficiary is the surviving spouse, RMDs are based on the surviving spouse’s life expectancy, starting no later than the December 31st of the year following the year of death. This life expectancy is recalculated each year. In the calendar year after the surviving spouse dies, RMDs are made based on the surviving spouse’s remaining life expectancy, reduced by one each calendar year.
--Of course, the surviving spouse can always roll the IRA over into his or her own IRA, assuming the spouse is the sole beneficiary, and then start taking RMDs when he or she reaches age 70½.
PRACTICE POINT: Make sure the surviving spouse is able to designate an individual to receive the remaining lifetime payments after his or her death.
B. Death without Designated Beneficiary. In the case of an IRA with no beneficiary, or a beneficiary with no life expectancy (such as an estate, charity, institution, or trusts which do not comply with Regulation Section 1.401(a)(9)-4, Q&A-5(b)), RMDs are calculated using the deceased IRA owner’s remaining life expectancy, starting no later than the December 31st of the year following the year of death. Each RMD thereafter is based on the remaining life expectancy reduced by one.
C. Designated Beneficiary Determination. A beneficiary no longer has to be designated by one’s required beginning date, as was the case under the Old Rules. Under the New Rules, the designated beneficiary does not have to be determined until distributions to the designated beneficiary must begin, which is the December 31st after the calendar year of death. This has confused some people, thinking that a beneficiary can be designated after death. If so, I will claim to be Bill Gates’ designated beneficiary after he dies. An IRA owner must designate his or her beneficiary before death. Unfortunately one of the undesired effects of the New Rules may be that people will become more lax about naming beneficiaries, since there is no longer a requirement to have a beneficiary designation at age 70½.
V. Other Special Rules
A. The Separate Share Rule. Under the Old Rules, if any of the designated beneficiaries had no life expectancy (such as a charity), a life expectancy could not be used for any of the beneficiaries in which to calculate IRA payments. For instance, if the IRA owner designates the Boy Scouts of America as a beneficiary to $1,000 of his IRA, and splits the rest of his IRA to his two children, because not all of the beneficiaries are individuals, a life expectancy could not be used when payments are to be made to the children. The way to avoid this problem was to create separate shares for each beneficiary. Under the Old Rules, the deadline for setting up the separate accounts was either the required beginning date, or the date of death after the RMDs had started.
Under the New Rules, the deadline for setting up separate accounts for after-death distributions is the December 31st of calendar year following the year of death. This will give the beneficiaries time to create separate accounts so that each individual’s life expectancy can be used. So, in the event one of the beneficiaries has no life expectancy (such as a charity), there is enough time to create separate accounts so that beneficiary life expectancies can be used.
The New Rules specify that beneficiary shares are deemed separate as long as investment gains or losses are allocated on a pro rata basis in a reasonable and consistent manner between shares (Regulation Section 1.401(a)(9)-8, Q&A-3).
B. Spousal Rollovers. Under the New Rules, a surviving spouse is able to roll over an inherited IRA only if the surviving spouse is the sole beneficiary of the account and has an unlimited right to withdrawal from the account. The New Rules also state that the surviving spouse can roll over an inherited IRA if he or she is the sole beneficiary of a trust which is the beneficiary to the IRA. This rule clears up an area that has been "muddied" by recent private letter rulings.
An example in the New Rules clarifies what being a "sole beneficiary" is considered to mean within a trust. In one example, some of the RMDs are accumulated for the benefit of the remainder beneficiaries. This caused the remainder beneficiaries to be considered beneficiaries of the IRA along with the surviving spouse, and accordingly the surviving spouse was not permitted to elect to delay taking RMDs until the deceased would have reached age 70½ (as permitted by Code Section 401(a)(9)(B)(iv)). In another example, the surviving spouse was entitled to the entire RMD; as a result the surviving spouse was considered to be the sole beneficiary of the IRA, meaning that options under Code Section 401(a)(9)(B)(iv) kick in (the options are rolling over the IRA, which can be done on the non-RMD portion, or waiting to take RMD when the deceased would have turned age 70½).
Does the requirement that the spouse be "sole beneficiary" mean there can be no other IRA beneficiaries outside of a trust? No, because under the separate share rules the spouse’s portion can be treated separately from the other beneficiary’s portion (if set up before the following December 31st), so an IRA owner can have multiple beneficiaries.
C. Trust Documentation Rule. The actual documentation that has to be provided (in order for the trust to be considered a "designated beneficiary") has not changed. What was changed is the deadline for furnishing the documentation. Under the Old Rules, documentation had to be furnished "by the end of the ninth month beginning after the employee’s date of death" (Proposed Regulation 1.401(a)(9)-1, Q&A D-6). Under the New Rules, the documentation must be furnished "by the last day of the calendar year immediately following the calendar year in which the employee died (Proposed Regulation 1.401(a)(9)-4, Q&A-6). This makes sense given that everything is tied into the December 31st date after the year in which the IRA owner died.
VI. Who benefits under New Rules in 2001. As stated, during 2001 IRA owners have the option of operating under either the Old or the New Rules. Those who will benefit under the New Rules include the following:
those who are over the RBD and have failed to designate a beneficiary (and are thus under a single life expectancy)
married couples who are close in age (the MDIB table would give them a higher life expectancy divisor)
those who are taking RMDs from a IRA on a joint non-recalculation basis (the MDIB life expectancies could be higher than this)
any beneficiaries to IRA wherein the IRA owner died last year, and are either co-beneficiary with a "non-life beneficiary" (such as a charity) or with one or more other beneficiaries who have shorter life expectancies
anyone who wants to change their designated beneficiary after the RBD
VII. Who doesn’t benefit under the New Rules. There is a situation where the Old Rules are preferable to the New Rules. Assume that the husband’s IRA beneficiary is a QTIP trust. At age 70½, he elects a joint non-recalculation method, using his life and the life of his wife. Should they die soon thereafter, the beneficiaries of the QTIP trust would be able to use the remaining joint life expectancy, reduced by one each year. Compare the same situation under the New Rules. Assuming that the husband dies first, then the wife soon thereafter after, under the New Rules the life expectancy used is the surviving spouse’s remaining life expectancy, reduced by one each year. Under the Old Rules the QTIP beneficiaries are better off since they could use a joint life expectancy.
VIII. Miscellaneous Q & A
Q: What if the IRA owner is already taking
RMDs, does he or she have to start using the new MDIB table to compute RMD?
A: In 2001, IRA owners can choose to go under the New Rules. Under the New Rules, the regulations do not specify how this election is to be made, or whether a written election has to be made at all. In my opinion, no written election has to be made from the IRA Owner.
In 2002, the New Rules are effective for all IRAs and retirement plans covered by the new proposed regulations.
Q: Who can make an election to come under
the New Rules in 2001? What if the IRA owner died last year?
A. The preamble to the new proposed regulations states that "taxpayers" may rely on either the Old or the New Rules in 2001. I believe the use of taxpayers was to cover those situations where the IRA owner is deceased, and payments have not yet begun in the year 2001. So, the IRA beneficiary should be able to come under the New Rules in 2001, and this would benefit the IRA beneficiary who is a co-beneficiary to a non-life beneficiary, such as a charity.
Q: What if the surviving spouse rolls over
her inherited IRA, does she use the MDIB table?
A: Yes, the surviving spouse becomes the IRA owner, so at age 70½ she would use the MDIB table to calculate her RMDs.
Q: What if an IRA owner turned age 70½ in
2000, and decided to wait until April 1 of 2001 to take his or her 2000 RMD. Can
the 2000 RMD use the New Rules?
A: No, the New Rules specifically apply to the 2001 RMDs and those RMD made in later years (IRS Announcement 2001-18 (2001-10 IRB)).
Q: Do the New Rules apply to a Roth IRA?
A: Yes, after the death of the IRA owner. A Roth IRA is not subject to the RMD rules during the life of the IRA owner, however, they do apply after the IRA owner has passed away.
Q: Under the Old Rules the payment of
expenses, debts or taxes from an IRA is analogous to designating the estate as
beneficiary, and therefore in such a situation the IRS does not recognize the
designated beneficiary. Has this rule changed?
A: No, this stupid rule still exists and hopefully will be changed in the future.
IX. Remaining Issues
A. Reporting. This is the big issue that will be decided in 2001. In my opinion, the reporting to both the IRA owners and the IRS will be done on the Form 5498, which must be distributed by the end of May. The Investment Company Institute, the trade organization which represents mutual funds, intends to lobby the IRS very strongly against creating a new form to report the RMDs. However, the IRS currently feels that providing next year’s RMD at year-end may be the way to go.
B. Substantially Equal Periodic Payments. Code Section 72(t)(2)(A)(iv) permits penalty-free distributions to be made before one turns age 59 ½ if they are part of substantially equal periodic payments. IRS Notice 89-25 sets forth three methods by which payments will comply with the Code Section 72(t)(2)(A)(iv) requirements (72(t) payments). One of the methods includes life expectancy payments based on the Code Section 401(a)(9) proposed regulations. The question then becomes whether such payments are calculated under the Old Rules, or under the New Rules. According to Marjorie Hoffman, the New Rules do not apply to 72(t) payments. She stated that the New Rules are only applicable once one reaches their required beginning date, and since 72(t) payments are made to those under age 59 ½, the Old Rules apply. Therefore, a single life expectancy, and not the MDIB table, is used to compute 72(t) payments.
This is a good result because those taking 72(t) payments are generally interested in maximizing the payment amount, which they can do under the Old Rules.
Death before RBD (Old Rules still apply here)
--Non spouse beneficiary
5 years to cash out, or
Single non-recalculated Life Expectancy beginning in 1 year
5 years to cash out, or
Can roll over IRA into her or his own IRA, or
Can keep IRA as is (deceased) until age 70½
RBD Options (New Rules apply)
MDIB Payments, or
Actual Joint Life Expectancy Payments if Spouse is more than 10 years younger
Death after RBD (New Rules apply)
If there is a DB (individual, certain trusts), payments continue under single life expectancy of DB, reduced by one each year
--If the DB is the spouse, payments continue under a single life expectancy of the surviving spouse, recalculated each year. After the spouse’s death, payments can continue over remaining life expectancy, reduced by one each year.
If there is no DB, payments continue over remaining life expectancy of IRA owner, reduced by one each year
Note: the DB must be determined by the December 31st in the year after the year of death.
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