Final regulations have been issued which govern required minimum distributions from IRAs and qualified plans. They generally follow the scheme articulated in the proposed regulations issued in January, 2001. Their use is mandated on January 1, 2003, but optional for calculating required minimum distributions in 2002. The final regulations dispense with the new reporting requirements until 2004.
The required minimum distribution for a participant is the account balance on December 31 of the prior year divided by the “applicable divisor” from the Uniform Lifetime Table, modified in 2002 to reflect longer life expectancies. For example, the applicable divisor for a person 70 years of age has been increased to 27.4 years from 26.2 years. Thus, the required minimum distribution of a participant 70 year of age required to take a distribution in 2002 from an account whose balance was $27,400 on December 31, 2001, would be $1,000. A longer (and more favorable) payout period would apply if the participant’s spouse were more than 10 years younger than the participant.
A participant must begin taking money out of an IRA or qualified plan by the “required beginning date,” which is generally the year the plan participant reaches the age of 70½. (If a participant owns less than 5% of a company which maintains a qualified plan, the required beginning date for withdrawals with respect to that plan is the later of age 70½ and the date of retirement.)
If the participant dies after the required beginning date, distributions to beneficiaries must commence by December 31 of the year that follows the year of the participant’s death. The distribution period for a nonspouse designated beneficiary is his remaining life expectancy, reduced by one in each subsequent year. If the participant’s spouse is the sole designated beneficiary, the distribution period is her single life expectancy, recalculated annually. (After her death, the distribution period for her named beneficiaries is her life expectancy in the year of her death, reduced by one in each succeeding year.) A special rule applies if the owner has failed to name a designated beneficiary: in that case, the distribution period is the owner’s remaining life expectancy in the year of his death, reduced by one in each subsequent year.
If the participant dies before the required beginning date, the distribution period is calculated in the same manner as if the participant died after the required beginning date, with one rather unpleasant exception: if no beneficiary designation was made, the account must be entirely distributed by December 31 of the fifth year following the participant’s death. Thus, it is important that a beneficiary designation be made before death, especially if the participant has not attained the required beginning date.
Under the final regulations, the date for “determining” the designated beneficiary is September 30 of the year following the year of the participant’s death. However, this does not mean that a failure to make a beneficiary designation prior to death can be cured during this time: The regulations point out that the period between death and the beneficiary determination date is a period during which beneficiaries can be eliminated, but not replaced. The failure to make a beneficiary designation before death is therefore a fait accomplis, despite the flexibility afforded by the new regulations in winnowing out designated beneficiaries after death.
Post-mortem planning to eliminate certain designated beneficiaries is important in achieving the longest payout period for all beneficiaries. It might be desirable to cash out a beneficiary with a short life expectancy before the designated beneficiary determination date, since the age of the oldest beneficiary is used in determining the payout period. Alternatively, it may be possible to split a single account into multiple accounts, so that the oldest beneficiary’s life expectancy does not result in an excessively short payout period for younger designated beneficiaries. (However, the regulations state that the separate account rules are not available to beneficiaries of a trust.) Matters of convenience aside, it may be critical to cash out a beneficiary such as a charity, whose presence as of the determination date would “taint” the designated beneficiary status of all individual beneficiaries. This would result in a mandatory 5-year required payout.
A surviving spouse who receives a distribution from an IRA or a qualified plan may, within 60 days, roll over that distribution into her own plan to the extent the distribution is not a required distribution, regardless of whether the surviving spouse is the sole beneficiary of the plan. Furthermore, if the spouse is the sole beneficiary of an IRA (not a qualified plan) and has full withdrawal rights, the spouse may elect to treat the entire IRA as her own. The election can be accomplished by (i) registering the IRA in the name of the surviving spouse; (ii) failing to take a required minimum distribution as beneficiary; or (iii) contributing to the IRA. Regardless of how the IRA becomes the spouse’s own, required minimum distributions will thereafter be determined solely by reference to the surviving spouse.
A rollover is not always possible: If the spouse is the beneficiary of a trust that qualifies as a designated beneficiary, she is not permitted to roll over any distributed amount. Even if possible, a rollover is not always advantageous: IRC § 72(t) imposes a 10% tax on withdrawals occurring prior to age 59½ by an account owner. The tax does not, however, apply to distributions made to beneficiaries.
The beneficiaries of a trust which has been named designated beneficiary of an IRA or qualified plan may be considered designated beneficiaries provided (i) the trust is irrevocable or becomes irrevocable upon the owner’s death; and (ii) the trust is valid under state law (or would be valid but for the fact there is no corpus); and (iii) the beneficiaries are easily identifiable. Generally, documentation concerning the trust must be provided to the IRA custodian or plan administrator by October 31 of the year following the participant’s death.