2002 Rules of the Road

©  George H. Coughlin II  2002  All Rights Reserved          Return to Home Page


The following discussion covers various tax rules relating to required distributions from qualified retirement plans, IRA's and §403(b) plans. The text is identical to the comments in the first part of Financial and Estate Planning Implications of the "Final" Minimum Distribution Rules:  Planning Opportunities Abound But Quicksand Remains For The Unwary. After completing the 2002 Rules of the Road, readers may wish to peruse another page on this web site entitled "2002 Planning Pointers".  It provides important reminders to individual participants, their beneficiaries and planning professionals.  

Disclaimer

Readers must take note that information presented in this document reflects the author’s attempt to describe various points of the Federal tax law.  Some important topics have been omitted.  Keep in mind that state tax laws may differ from the Federal rules.  While every effort has been made to accurately report the provisions of the Internal Revenue Code and the Regulations pertaining thereto, it is possible that a misrepresentation has occurred.  Naturally, the Code and Regulations control the tax treatment of any situation, not the author’s interpretation.  Therefore, taxpayers should rely on the tax law rather than positions put forth in this paper.

George Coughlin is NOT responsible for, and cannot control the content of, the material listed in “Other Resources” below.  In fact, those reference items, software programs and web sites may provide incorrect information, produce inaccurate results or make false statements.   Furthermore, any investment or insurance advice as well as recommendations to purchase or sell securities you receive from a resource listed on IRAplanning.com does NOT involve George Coughlin or his broker/dealer Foothill Securities, Inc.  Please use appropriate caution.  

2002 Rules of the Road


Which Retirement Plans Are Impacted and When Do The "Final" Rules Take Effect?

The final regulations on required distributions published by the Service on April 17, 2002 apply to both defined contribution and defined benefit plans under §401(a).  They also impact individual retirement accounts and individual retirement annuities under §408.  In addition, they cover §403(b) tax sheltered annuity (TSA) contracts purchased, or custodial accounts or retirement income accounts established, by a §501(c)(3) organization or public school.  Lastly, the 2002 rules pertain to required distributions from certain deferred compensation plans for employees of state and local governments under §457(d)(2).

The final regulations apply to distributions for calendar years beginning on or after January 1, 2003 that come from all account balances and benefits in existence on or after January 1, 1985.  [§1.401(a)(9)-1, A-2]  For distributions for the 2002 calendar year, taxpayers may rely on the final regulations, the 2001 proposed regulations or the 1987 proposed regulations.  In the case of distributions during a participant’s lifetime, the final regulations will produce the lowest required distribution in all cases that the author has explored.  The same is true when calculating most, but NOT all, postmortem distributions.  Therefore, beneficiaries would be wise to compute minimum distributions under all three possibilities so they can be certain that their choice is the most favorable.  

Please note that throughout this text the expression “qualified retirement plan(s)” or “qualified plan(s)” is used to denote pension plans, profit sharing plans, stock bonus plans, traditional individual retirement accounts (IRA’s) under IRC §408, Roth IRA’s under IRC §408A and tax sheltered annuities under IRC §403(b).  Whenever IRC §401(a)(9) does not apply uniformly to all six entities, the exception will be noted.  None of the comments on these pages address the application of IRC §401(a)(9) to so-called Section 457 Plans for government workers.  Furthermore, the text does not include a discussion of annuity payments from a defined benefit plan, an individual retirement annuity or an annuity contract purchased by an individual account in a defined contribution plan.     

It is important to remember that a Roth IRA provides several significant exemptions from IRC §401(a)(9).  The first is an avoidance of required distributions during the owner’s lifetime.  That is to say, Roth IRA’s are immune from IRC §401(a)(9)(A).  They are also exempt from the Minimum Distribution Incidental Benefit provisions of IRC §401(a).  Furthermore, Roth IRA’s are not impacted by IRC §401(a)(9)(B)(i) when the owner dies.  Instead, beneficiaries need only adhere to the relatively straightforward procedures of IRC §401(a)(9)(B)(ii) and (iii).  Essentially, those are the same rules that apply to non-spouse beneficiaries when traditional IRA owners die before their required beginning date.  That means beneficiaries have only one set of rules to follow regardless of the age of the Roth IRA owner on his/her date of death.

 

Why Were The Minimum Distribution Rules Created?

Simply put, money set aside and accumulated in qualified retirement plans is granted favorable tax treatment with the expectation that it will be used for retirement income purposes.  To curtail one potential abuse of that opportunity, Congress decided to set duration limits on the tax deferral aspect of all qualified retirement plans.  IRC §401(a)(9) is the mechanism to accomplish that objective.  Under the guidelines contained in that paragraph, everyone is forced to begin making withdrawals at a prescribed level from all their retirement plans at a specified date even if they do not need the extra revenue and/or would prefer to leave the capital in their respective plans. 

 

When Do The Rules Come Into Play and How Do They Operate?

The minimum distribution rules are best known for their impact on taxpayers that have reached age 70˝.  Those are the so-called “living” requirements.  However, they have an equally important impact following the death of the plan participant.

A.                Unless a limited exception applies (see page 6), the “living” aspects of the required distribution provisions found in IRC §401(a)(9)(A) kick into gear during the year a participant reaches age 70˝. 

1.                 Technically speaking, the withdrawal for the first distribution calendar year may be delayed until April 1 of the year immediately following the year in which someone attains age 70˝.  That date is referred to as their Required Beginning Date or RBD.  [§401(a)(9)(C)]  Please follow the hyperlink in the preceding sentence for a complete definition of “RBD” -- including an exception for certain participants.  At the same time, be sure to double check the definition of “distribution calendar year”.

2.                 If the taxpayer elects to delay making the minimum withdrawal for the first distribution calendar year until sometime between January 1 and April 1 of the year after they reach age 70˝, they are still required to make a minimum distribution from their qualified plan for the second distribution calendar year not later than December 31 of the year they attain age 71˝.  Therefore, the election to delay the first year’s payment forces two taxable distributions to occur in a single year -- the year they turn age 71˝.  [§1.401(a)(9)-5, A-1(c)] 

3.                  Rules similar to those outlined in the previous paragraph also apply to a select group of participants who may delay their RBD until the year after they retire, if retirement follows the year they attain age 70˝.  (For more details, please refer to the discussion of “Required Beginning Date”.)  Those special retirees must take a required distribution from their plan for the year in which they retire – their first distribution calendar year.  That withdrawal for the initial year may be delayed until April 1 of the year following the year they retire from employment with the employer maintaining the plan.  Such a delay, however, does not relieve the participant of the need to also take a minimum required distribution for the year following their retirement – their second distribution calendar year.  [§1.401(a)(9)-2, A-2(a)] 

4.                 A further delay is possible for the pre-1987 portion of tax-sheltered annuity plans (TSA’s) covered under IRC §403(b).  Please note, however, that all post-1986 earnings and contributions are subject to the normal required distribution rules.  [§1.403(b)-3, A-3] 

B.                The same paragraph of the Internal Revenue Code that mandates lifetime withdrawals also stipulates the minimum distributions that must be carried out following the death of a participant.  The postmortem rules break down into two subcategories depending on when the participant dies.  

1.                  If death takes place before the required beginning date, the final regulations closely parallel the provisions of the 2001 and 1987 proposed regulations.  It should be noted, however, that if the account has a Designated Beneficiary, the default method in the final regulations is the life expectancy rule, referred to below as the General and Spousal Exceptions.  In the 1987 proposed regulations, the Five-Year Rule served as the default.   Under certain circumstances, that subtle shift can have a favorable impact on beneficiaries that are otherwise eligible to use the General Exception but failed to meet the requisite deadline to commence those distributions.  See item “S” in the Assorted Planning Pointers for more details.   

a)                Although a qualified retirement plan, IRA or TSA is permitted to be more restrictive, the first option under the new rules allows assets in those qualified plans to be withdrawn at anytime during the period that ends on December 31 of the fifth year following the year of the participant’s death.  [§401(a)(9)(B)(ii)]  

b)                 There is a General Exception to the Five-Year Rule available for any portion of the participant’s interest in the account payable to someone who qualifies as a “Designated Beneficiary”.  (Please read the definition of that term as well as the discussion of separate accounts.)  A sole Designated Beneficiary (DB) may elect to pull assets out of the plan over his or her own life expectancy, or a shorter period, provided those withdrawals begin by the end of the year immediately following the year of the participant’s death.  The tax code also allows one heir in a group of Designated Beneficiaries to receive his/her share of the plan over the life expectancy of the oldest DB even though the other members in the group take 100% of their share immediately.  If the qualified plan is broken into separate accounts, the DB of each separate account may use his or her own life expectancy when computing required distributions.  [§401(a)(9)(B)(iii)]   

c)                  The Spousal Exception to the Five-Year Rule offers a surviving spouse even greater flexibility than the general exception.  [§401(a)(9)(B)(iv)]  Provided the participant’s spouse is the sole Designated Beneficiary of the entire qualified plan or a separate account within that plan, distributions must commence by the later of the date specified for the General Exception or the end of the calendar year in which the employee would have attained age 70˝.  (Please refer to the discussion of separate accounts.)   

d)                 The flow chart on Table 22 entitled “Tax Rules Governing Postmortem Distributions From Qualified Plans” spells out the details of the preceding options.  Table 26 illustrates the potential value of stretching out distributions using the General Exception.   Please note that qualified plans can restrict a beneficiary’s options.  A review of those restrictions begins later in this document under the heading “Can The Qualified Plan Limit Your Planning Options?” 

2.                  If the participant dies on or after the RBD, his/her assets remaining in the qualified plan must be distributed at least as rapidly as under the METHOD of distribution being used to satisfy the MRD rules on the date of the participant’s death.  [§401(a)(9)(B)(i)]  The final regulations published on April 17, 2002 significantly modify the Service’s previous interpretation of the “at least as rapidly” rule that was explained in the original proposed regulations published in 1987.  [§1.401(a)(9)-2, A-5]  The postmortem provisions of the final regulations appear in flow chart format on Tables 25A and 25B of this document.  The financial implications of those rules are illustrated on Tables 27A through 29C

 

What Is The Minimum Annual Distribution During Your Lifetime? 

Please remember that a minimum required distribution is exactly what the title states.  It is only a minimum.  [§1.401(a)(9)-5, A-1(a)]  Taxpayers are free to withdraw a greater amount anytime they wish.  Regrettably, any excess taken out one year may not be used to offset a portion of the required amount in a future year.  [§1.401(a)(9)-5, A-2]  Roth IRA owners need not make required distributions during their lifetime.  [§401A(c)(5)(A)]   

A.                Calculating minimum required distributions during a participant’s lifetime is relatively straightforward.  The process is represented by the following mathematical equation.   

MRD20XX = Account Balance At End of Preceding Year ¸ Applicable Distribution Period 

1.                  With one rather unique exception outlined immediately below, the Applicable Distribution Period used in the formula for each year, including the year of the participant’s death, is the factor shown on the Uniform Lifetime Table shown in §1.401(a)(9)-9, A-2 that corresponds to the participant’s age as of that person’s birthday in the relevant distribution calendar year.   

2.                  In the event the sole Designated Beneficiary of a participant is his or her spouse, the applicable distribution period might be longer.  It depends on the age spread between the spouses.  The participant may use the longer of the factor derived from the table mentioned in the preceding paragraph or the joint life expectancy of the spouses shown on the Joint and Last Survivor Table in §1.401(a)(9)-9, A-3 based on their attained ages as of their respective birthdays in the distribution calendar year.  Anytime the sole DB is a non-participant spouse born more than ten calendar years after the participant’s year of birth, the couple’s joint life expectancy will be longer than the factor from the Uniform Lifetime Table.  [§1.401(a)(9)-5, A-4(b)]

3.                  Table 21A of this document entitled “Calculating Minimum Required Distributions During Participant’s Lifetime” provides an example of the calculation process.  Also attached is Table 21B listing all the distribution periods from the Uniform Lifetime Table.    

B.                 Keep in mind that aggregation rules are available for required distributions from multiple IRA’s and §403(b) Tax Sheltered Annuities.  Unfortunately, pension, profit sharing and stock bonus plans are NOT eligible for this benefit.  Revenue Notice 88-38]   

1.                 This means that a taxpayer with three IRA’s could pull the sum of the MRD’s individually computed for each of the three accounts entirely from the lowest yielding IRA rather than pro rata from all three.  The same would be true if the client had a trio of TSA’s.   Please note, however, that the final regulations modify Revenue Notice 88-38 by disallowing withdrawals taken out of an inherited IRA or TSA from satisfying required distributions a person must remove from his or her own IRA or TSA.  Although distributions to a beneficiary of the same decedent may be aggregated, such amounts may not be used to satisfy minimum withdrawals to the same beneficiary from IRA’s or TSA’s of other decedents.  [§1.408-8, A-9 and §1.403(b)-3, A-4] 

2.                  It is not permissible to take IRA minimum required distributions from a low yielding TSA or vice versa.  Furthermore, withdrawals from a Roth IRA will not satisfy the distribution requirements applicable to Traditional IRA’s or §403(b) accounts.  In addition, assets removed from those accounts cannot be used to fulfill the postmortem MRD’s from Roth IRA’s.

 

Technical Terms And Concepts You Need To Understand 

While the final regulations issued by the Service in April of 2002 are a lot less complex than the original ones published in 1987, they do not fall under the heading “tax simplification”.  The 2002 Rules of the Road still require travelers to know the definition of a few important terms and have a working knowledge of several interdependent concepts before leaving home for a trip across town. 

A.                Required Beginning Date (RBD):  All IRA owners as well as participants in qualified plans that own more than five percent of the sponsoring employer must begin distributions no later than April 1 of the year following the year in which the participant attains age 70˝.  The RBD for all other employees and §403(b) plan participants is April 1 of the calendar year following the later of either:  (1) the calendar year in which the employee attains age 70˝, or (2) the calendar year in which the employee retires from employment with the employer maintaining the plan.  [§401(a)(9)(C)]   Note, however, that under §1.401(a)(9)-2, A-2(e) a plan may elect to use the RBD rules mandated for IRA’s for all employees, i.e., April 1 of the year following the year the employee attains age 70˝.  Therefore, it is necessary to determine if such an election has been made for the plan in question before it is possible to be certain about the Required Beginning Date for its participants.  It is also important to keep in mind that the special rule for extending the RBD only applies to qualified plans and §403(b) plans maintained by the participant’s current employer.   The RBD rules for all plans associated with a former employer are the same as for IRA’s.   

B.                 Distribution Calendar Year (DCY):  A calendar year for which a minimum distribution is required is a distribution calendar year.  For example, the calendar year in which an IRA owner attains age 70˝ is his or her first DCY, even though the actual withdrawal may take place during the first quarter of the following year.  The year containing his or her required beginning date is that person’s second distribution calendar year.  The first DCY for a beneficiary occurs in the calendar year during which he or she must take the first distribution from the inherited account.  [§1.401(a)(9)-5, A-1(b)]   

C.                 Account Balance:  The benefit used in determining the minimum required distribution for a distribution calendar year is the market value of the account as of the last valuation date in the calendar year immediately preceding that DCY.  Although the valuation date may vary from one qualified plan to another, the final regulations specify that it must fall on December 31 for IRA’s and §403(b) plans.  The account balance used to calculate MRD’s for the second DCY is not adjusted when a participant delays taking the minimum withdrawal for his or her first distribution calendar year until the first quarter of the following year.  This differs from the 1987 and 2001 proposed regulations which stipulate that the account balance used for computing the required distribution for the second DCY is the market value at the end of the preceding year less the minimum distribution that was delayed.  [§1.401(a)(9)-5, A-3 and §1.408-8, A-6]     

D.               Applicable Distribution Period (ADP):  This is the divisor in the mathematical equation used to compute the required distribution for a given distribution calendar year.  For distributions during a participant’s lifetime, including the year of his or her death, the ADP is obtained in the manner described in item “A” of the section above entitled “What Is The Minimum Annual Distribution During Your Lifetime?” and illustrated on Table 21A.  The ADP used for computing distributions following the year of a participant’s death is derived from the Single Life Table in §1.401(a)(9)-9, A-1.  Postmortem MRD’s are calculated in accordance with §401(a)(9)(B) of the Internal Revenue Code as well as §1.401(a)(9)-5, A-5(a) and (b) of the final regulations.  (See the flow charts on Tables 22, 25A and 25B for a detailed explanation of postmortem distributions.) 

E.                 Designated Beneficiary (DB):  A Designated Beneficiary is an individual who is entitled to receive a portion of the benefits of a qualified plan following the death of the participant or another specified event.  It is important to note that it is possible to name a beneficiary for a qualified plan but NOT have a “Designated Beneficiary”.  (See item “J” below for examples.)  Please refer to item “G” below for a discussion of how to identify a DB when a trust serves as beneficiary.  Readers should also become familiar with the comments in item “L” below that deal with the necessity to redetermine the identify of an account’s DB’s if the participant died before 2003.   

1.                  The “designation” must be spelled out in the plan itself or with an affirmative election by the plan participant.  [§1.401(a)(9)-4, A-1 and A-2]  

a)                 It is not valid if merely stipulated under state law.  

b)                 It is not valid to simply use a joint and last survivor annuity settlement without also naming a beneficiary.   

2.                  The Internal Revenue Code only allows a Designated Beneficiary to be an individual or group of individuals.  However, see item “G” below for circumstances in which DB status is achieved if a trust serves as beneficiary.  [§.401(a)(9)(E)]  

a)                 The individual must be identifiable under the plan as of the participant’s date of death and remain a beneficiary as of September 30 of the calendar year following the year of the participant’s death – the Designation Date.   (See item “F” below.)  [§1.401(a)(9)-4, A-4(a)]   

b)                 Members of a class of beneficiaries capable of expansion or contraction will be treated as being identifiable if it is possible, as of the date the designated beneficiary is determined, to identify the class member with the shortest life expectancy.  [§1.401(a)(9)-4, A-1] 

c)                  An individual who is a beneficiary as of the date of the participant’s death and dies prior to September 30 of the year following the year of the participant’s death without disclaiming, continues to be treated as a beneficiary on the Designation Date for purposes of identifying the DB, regardless of the identity of the successor beneficiary who is entitled to distributions as the beneficiary of the deceased beneficiary.  [§1.401(a)(9)-4, A-4(c)] 

3.                  Under the final regulations, a Designated Beneficiary must be a beneficiary as of the participant’s date of death and remain a beneficiary on the Designation Date.  Consequently, any person who is a beneficiary as of the date of the participant’s death, but is not a beneficiary on September 30 of the following year, is ignored.  [§1.401(a)(9)-4, A-4(a)]  That same citation in the final regulations mentions two circumstances in which a beneficiary on the participant’s date of death would not be considered a beneficiary as of Designation Date.    

a)                  If a beneficiary executes a qualified disclaimer under I.R.C. §2518 by the Designation Date, that person will not be taken into account in determining the participant’s Designated Beneficiaries.  When reading this provision please remember that unless a participant actually died on December 31, the deadline for making a qualified disclaimer differs from the September 30 Designation Date.   

b)                 If a beneficiary receives the entire benefit to which he or she is entitled before September 30 of the year following the year in which the participant died, that person or entity will not be considered a beneficiary for designated beneficiary purposes.   

F.                 Designation Date:  The designation date is September 30 of the year immediately following the year of a participant’s death.  This is the date of record used when determining if an account has one or more Designated Beneficiaries.   See paragraph 3 in item “E” above for more details.  Please note that this term is the author’s own creation.  It does not appear in the Code or Regulations. 

G.               Trust As Beneficiary:  Under certain circumstances specified in the final regulations, DB status can be achieved if a trust is named as beneficiary.  Please note that the trust itself is not the Designated Beneficiary since only an individual human being may be a DB.  However, the beneficiaries of the trust will qualify as DB’s if the trust meets certain requirements.  [§1.401(a)(9)-4, A-5(a)]  Table 23 lists a summary of those requirements that are spelled out in detail below.   

1.                 A Designated Beneficiary can exist when a trust is the qualified plan’s beneficiary provided four requisites are met.  [§1.401(a)(9)-4, A-5(b)]   

a)                The trust is valid under state law, or would be but for the fact that there is no corpus. 

b)                The trust is irrevocable or will, by its terms, become irrevocable upon the death of the participant. 

c)                  The trust’s own beneficiaries who will be receiving proceeds from the qualified plan are named individuals or identifiable from the trust instrument, e.g., a class of beneficiaries such as spouse, children, etc. is acceptable.   The members of a class of beneficiaries capable of expansion or contraction will be treated as identifiable if it is possible to identify the class member with the shortest life expectancy.   

d)                Certain documentation is provided to the plan administrator so that the beneficiaries of the trust who are beneficiaries with respect to the trust’s interest in the participant’s benefit are identifiable to the plan administrator.  Please note that for purposes of all the documentation rules outlined herein, an IRA trustee, custodian or issuer is treated as the plan administrator.   [§1.408-8, A-1(b)]  The trustees, custodians and issuers of TSA contracts under §403(b) are also treated as the plan administrator.  [§1.403(b)-3, A-1(b)]     

2.                  For purposes of required distributions during the participant’s lifetime, it is only necessary to fulfill all four of the requisites if the sole designated beneficiary is the participant’s spouse and that DB was born more than ten calendar years after the year of the participant’s birth.  It should be noted that no deadline exists for satisfying those four conditions in order to qualify for the Younger Spouse Rule.  Until all four are met, however, the participant must use the less advantageous ADP’s from the Uniform Lifetime Table.  Therefore, it is prudent to fulfill the four requirements not later than the date on which the trust becomes a beneficiary of the qualified plan or the participant’s RBD – as well as during all subsequent periods in which the trust serves as a beneficiary.  [§1.401(a)(9)-4, A-6(a)]   

a)                 The participant provides a copy of the trust instrument to the plan administrator and agrees that if the trust instrument is amended at any time in the future, he/she will, within a reasonable time, provide to the plan administrator a copy of each such amendment.   

b)                 The participant provides the plan administrator with a list of all the beneficiaries of the trust (including contingent and remainder beneficiaries) along with a description of the conditions for their entitlement.  He or she must certify that, to the best of his/her knowledge, the list is correct and complete and that the requirements of 1 a), b), c) and d) above are satisfied.  In addition, the plan participant must agree to provide corrected certifications if an amendment changes any information previously certified.  Finally, the participant agrees to provide a copy of the trust instrument to the plan administrator upon demand. 

3.                  For purposes of required distributions following a participant’s death, items a) and b) in item 1 above must be satisfied as of the date of death.  Requirement c) must also be fulfilled on September 30 of the year following the year of the participant’s death.  Requisite d) in item 1 above must be completed by October 31 of the year immediately following the year the participant dies.  Taking either of the following steps can satisfy the postmortem documentation requirement.  [§1.401(a)(9)-4, A-6(b)]   

a)                 The trustee provides the plan administrator with a copy of the actual trust document for the trust that is named as a beneficiary of the participant under the qualified plan as of the date of death.   

b)                 The trustee provides the plan administrator with a final list of all the beneficiaries of the trust as of October 31 of the year following the year the participant died (including contingent and remainder beneficiaries) along with a description of the conditions for their entitlement.  The trustee must certify that, to the best of the trustee’s knowledge, the list is correct and complete and that the requirements of 1 a), b) and c) above are satisfied.  In addition, the trustee agrees to provide a copy of the trust instrument to the plan administrator upon demand.    

4.                  Payments to a trust from a qualified plan after the participant’s death need not be distributed to the trust’s own beneficiaries.  That is to say, such payments may be retained inside the trust for distribution to its beneficiaries at anytime in the future.  [§1.401(a)(9)-8, A-11]  

H.               Calculation-DB:  If a group of individuals are DB’s, the person with the shortest life expectancy will be the Designated Beneficiary for purposes of selecting the life expectancy factor to use in MRD calculations.  [§1.401(a)(9)-5, A-7(a)(1)]  This person is sometimes referred to as the “calculation-DB” although that term does not appear in the Code or Regulations.  

1.                  In the event one or more of the beneficiaries of an account as of September 30 of the year following the year the participant dies does not qualify as a Designated Beneficiary, the participant will be treated as not having any DB’s.  This is true even if the other beneficiaries are individuals that fulfill the DB requirements.  NOTE:  This rule applies regardless of when death occurs.  [§1.401(a)(9)-4, A-3] 

2.                  The existence of a contingent beneficiary usually has no bearing on determining the individual DB with the shortest life expectancy or whether there is a beneficiary that does not qualify as a DB.  However, a contingent will be treated as a primary beneficiary for either purpose if that contingent beneficiary is entitled to receive a portion of the participant’s benefit beyond being a mere potential successor to the interest of one of the participant’s primary beneficiaries upon that beneficiary’s death.  Here is the example that illustrates this point in §1.401(a)(9)-5, A-7(c)(1).  “If the first beneficiary has a right to all income with respect to an employee’s individual account during that beneficiary’s life and a second beneficiary has a right to the principal but only after the death of the first income beneficiary (any portion of the principal distributed during the life of the first income beneficiary to be held in trust until that first beneficiary's death), both beneficiaries must be taken into account in determining the beneficiary with the shortest life expectancy and whether only individuals are beneficiaries.” 

I.                    Separate Accounts:   The separate account rule is so technical that it is necessary to begin a discussion of the subject by providing the following direct quote from §1.401(a)(9)-8, A-3(a) of the final regulations.  “For purposes of §401(a)(9), separate accounts in an employee’s account are separate portions of an employee’s benefit reflecting the separate interests of the employee’s beneficiaries under the plan as of the date of the employee’s death for which separate accounting is maintained.  The separate accounting must allocate all post-death investment gains and losses, contributions, and forfeitures, for the period prior to the establishment of the separate accounts on a pro rata basis in a reasonable and consistent manner among the separate accounts.  However, once the separate accounts are actually established, the separate accounting can provide for separate investments for each separate account under which gains and losses from the investment of the account are only allocated to that account or investment gain or losses can continue to be allocated among the separate accounts on a pro rata basis.  A separate accounting must allocate any post-death distribution to the separate account of the beneficiary receiving that distribution.”   Separate accounts with different beneficiaries under the plan can be established at any time, either before or after the participant’s RBD.  However, separate accounts for beneficiaries entitled to a fractional or percentage interest must be established before December 31 of the year following the year of the participant's death in order to isolate non-DB's from individual beneficiaries, thus allowing the latter to enhance their stretch-out potential.  By subdividing a single account into separate shares (accounts) by the end of the year following the year of the participant's death, it is also permissible to use the life expectancy of the oldest beneficiary of each respective share when determining the distribution period for that separate account.  Therefore, a Designated Beneficiary (with a short life expectancy) on one separate account within a qualified plan can be ignored when determining the calculation-DB on another separate account.  (If you truly understand this entire paragraph, please submit your résumé to the IRS – they have just the job for you.)  

J.                    Non-DB Status:  Naming a charity, partnership, corporation or an estate as a partial or total beneficiary of a separate account within a qualified plan means that at least a portion of the assets will pass to a non-human entity.  If one of the beneficiaries for a separate account is such an entity, that separate account will be treated as not having a Designated Beneficiary even though the other beneficiaries are humans.  [§1.401(a)(9)-4, A-3] 

K.                Spousal Rollover IRA:  There are three methods by which a person that is a beneficiary of his or her deceased spouse’s qualified plan or IRA may reposition those assets into an individual retirement account and elect to treat the new account as his or her own.  This is true regardless of when the participant dies.  Throughout this document, that new account is referred to as a “Spousal Rollover IRA” – regardless of the steps taken to create it.      

1.                 A surviving spouse beneficiary may create a spousal rollover IRA by simply assuming ownership of the deceased owner’s individual retirement account.  It is important to note that this method is only available with IRA’s, not other forms of qualified retirement plans.  Furthermore, the surviving spouse must be the sole Designated Beneficiary of the entire account or a separate share and have the unlimited right to withdraw amounts from the IRA.   

a)                 If an election is made to treat the account as the surviving spouse's own during the IRA owner’s year of death, the surviving spouse beneficiary may NOT assume ownership of the portion of the decedent’s account equal to the MRD for the current year that somehow failed to be distributed to the participant before death.  [§1.408-8, A-5(a)]  Instead, the spouse must withdraw the previously undistributed amount of the MRD and recognize its taxable portion on that year’s income tax return.     

b)                 In the event the surviving spouse elects to treat the account as his or her own in any year following the year of the IRA owner’s death, the surviving spouse beneficiary is allowed to retitle the entire account or separate share – including the MRD, if any, for the current year that would otherwise need to be taken as beneficiary.  No aspect of the ownership change constitutes a taxable event.   Please note, however, that under this scenario, the account is treated as belonging to the survivor as of December 31 of the preceding year.  Therefore, the lifetime required distribution rules apply for the year of the ownership change based on the attained age of the surviving spouse.  [§1.408-8, A-5(a)] 

2.                  A surviving spouse beneficiary may create a spousal rollover IRA under §402(c)(9) by rolling over assets distributed to him or her from a qualified retirement plan such as a pension, profit sharing or stock bonus plan.  Provided the surviving spouse subsequently elects to treat the IRA as his or her own, the tax ramifications are identical to the explanation found in paragraph 3 immediately below.  [§1.408-8, A-7]  Please note, however, that a surviving spouse need not elect to treat the IRA as his or her own following the rollover of assets from a deceased participant's pension, profit sharing or stock bonus plan.  In such a case, the surviving spouse remains the beneficiary of the Individual Retirement Account without assuming ownership.  Hence, the IRA remains a beneficiary distribution account instead of becoming a spousal rollover IRA and required distributions must be determined under the postmortem guidelines when a spouse is beneficiary.   

3.                  It is also possible to create a spousal rollover IRA when a surviving spouse is not the sole beneficiary of a deceased IRA owner’s account.  To do so, the survivor transfers the portion of the account to which he or she is entitled into an individual retirement account in the survivor’s own name.   By following this strategy, the applicable tax treatment differs slightly from the procedures discussed in paragraph 1 of this section K.  Regardless of the year of the rollover, the surviving spouse beneficiary must treat withdrawals from the decedent’s IRA as first fulfilling the current year’s required distribution to him/herself as beneficiary.   Therefore, any portion of the year’s required distribution not yet removed from the old account may NOT be rolled over into the spousal rollover IRA.  Thus, a surviving spouse must first remove sufficient funds from the decedent's account to satisfy the current year's MRD to him/herself as beneficiary (and recognize that amount as taxable income) before rolling over the balance.  Because the survivor is the owner of the spousal rollover IRA, the account is subject to the lifetime required distribution rules based on the owner's attained age each year beginning in the year following the year of the rollover.  [§402(c)(9) and §1.408-8, A-7]           

L.                 Redesignation/Reconstruction Rule:  The final regulations state that required distributions apply to account balances and benefits held for beneficiaries for calendar years beginning on or after January 1, 2003.  This is true even if the participant died prior to the start of 2003.  Therefore, in every case of a participant that died before January 1, 2003, the DB must be redetermined in accordance with the provisions of the final regulations and the applicable distribution period must be reconstructed using those same regulations when it is time to compute MRD’s for distribution years 2003 and later.  Please note that this rule cannot alter the recipients of the benefits, but it may well change the level of those distributions because the calculation-DB under the final regulations could differ from the person whose life expectancy is used for calculation purposes under the 2001 or 1987 proposed regulations.  [§1.401(a)(9)-1, A-2(b)(1)]   

 

Can The Qualified Plan Limit Your Planning Options? 

All the distribution planning in the world may be for naught if the plan document blocks the desired implementation.  The tax rules and regulations previously cited are contingent, in many ways, on the provisions of the qualified plan.  This means that a participant’s tax and estate planning preferences may not be available through the current trustee.  Of course, a participant or Designated Beneficiary can execute a trustee-to-trustee transfer between IRA’s and TSA’s to obtain more flexible distribution options or a wider array of investment opportunities.  Unfortunately, that remedy is not available to participants of pension, profit sharing or stock bonus plans (QRP's) unless they terminate their participation and roll over a lump sum distribution from the plan into an IRA.  Of course, a surviving spouse named as beneficiary of any of those QRP's can work around the problem by using a spousal rollover IRA, but even that solution may interfere with the estate plan.  Unlike a spouse who is named as a beneficiary, a non-spouse beneficiary of such plans is not allowed to roll over the QRP into an IRA in their own name.  Starting in 2007, however, a non-spouse beneficiary of a pension, profit sharing or stock bonus plan may execute a trustee-to-trustee transfer of the QRP assets into an inherited IRA.  The latter must be titled in the name of the deceased participant for the benefit of the same beneficiary and list that beneficiary's Social Security Account Number (SSAN) as the Taxpayer Identification Number (TIN) for the account.  The same rules apply if a trust, rather than an individual, is the non-spouse beneficiary.  

A.               When a participant DIES BEFORE THE REQUIRED BEGINNING DATE, the applicability of the five-year rule and its two exceptions depends as much on the plan’s language as it does on the wishes of the beneficiary.  (See the flow chart on Table 24 entitled “Plan Restrictions Control Postmortem Distribution Options Before The Required Beginning Date”)  Please note that a qualified plan is allowed to effectively eliminate all the postmortem options available under the tax rules by requiring a complete distribution at some point before the deadline imposed by the Five-Year Rule.  This could be a major blow to postmortem planning by the survivors unless a trustee-to-trustee transfer can be used to reposition the assets to a plan with more liberal provisions.   

1.                  If the plan does not include a provision describing the method of distribution after the death of a participant, the final regulations specify that distributions MUST conform to the following rules.   

a)                 In cases where there is a Designated Beneficiary, distributions are to be made in accordance with either the “General Exception” or the “Spousal Exception” to the Five-Year Rule.   [§1.401(a)(9)-3, A-4(a)(1)]  

b)                 All other cases must adhere to the Five-Year Rule.  [§1.401(a)(9)-3, A-4(a)(2)] 

2.                  Under the final regulations, a qualified plan may adopt provisions specifying how distributions will be carried out if the participant dies before his/her required beginning date.  For example, a plan is allowed to establish one method for a surviving spouse and another for non-spouse beneficiaries.  However, there must be a single method covering the distribution of all benefits in each separate account belonging to a participant.  Note also that the plan rules may be more restrictive than the tax law.  [§1.401(a)(9)-3, A-4(b)]  

a)                 Every beneficiary could be forced to withdraw under the provisions of the Five-Year Rule or before an earlier date.   

b)                 A Surviving spouse might be allowed to use the General Exception or Spousal Exception while all others would be restricted to the Five-Year Rule or an earlier withdrawal deadline.   

c)                  Non-spouse beneficiaries might be permitted to use the General Exception but a spouse would be limited to the Five-Year Rule or an earlier withdrawal deadline.  

d)                All beneficiaries could be required to use either the General Exception or the Spousal Exception depending on their relationship with the deceased participant.  NOTE:  This does not present a problem because a beneficiary may always accelerate withdrawals if he/she wants to rapidly drain the account. 

3.                  The plan may allow an election by the participant or their beneficiaries.  If such an election is possible, the plan may specify which method of distribution applies if neither the participant nor the beneficiary makes that election.  In the event neither party elects a method and the plan fails to stipulate which rule applies, the proposed regulations state that distributions must be made as if the plan contained no option provisions (see #1 above).  [§1.401(a)(9)-3, A-4(c)]   

a)                 The election must be made by the earlier of

(1)              December 31 of the calendar year in which distribution would be required to commence to satisfy the two exceptions to the Five-Year Rule, or  

(2)              December 31 of the calendar year that contains the fifth anniversary of the participant’s death.   

b)                 As of such date, the election must be irrevocable with respect to the beneficiary and all subsequent beneficiaries.  

c)                  The election must apply to all subsequent years.  

4.                  The final regulations provide a transition rule that will allow certain Designated Beneficiaries of participants that died before their Required Beginning Date to use the General Exception, even though the beneficiary failed to take the MRD’s starting in the year following the year of the participant’s death.  [§1.401(a)(9)-1, A-2(b)(2)]  A thorough explanation of this point is available in Planning Pointer “S”.   

B.                 When a participant DIES ON OR AFTER THE REQUIRED BEGINNING DATE, the “... at least as rapidly ...” phrase in IRC §401(a)(9)(B)(i)(II) leaves plenty of latitude for qualified plans to foil distribution planning.  For example, it is not uncommon to run across corporate-sponsored retirement plans that force non-spouse beneficiaries to make a 100% withdrawal as soon as reasonably possible.   Fortunately, IRA’s and TSA’s seldom have such draconian provisions.  [Remember, IRC §401(a)(9)(B)(i)(II) does NOT apply to Roth IRA’s because no method is used to compute required distributions before the owner’s death.]     

1.                  Although having plan provisions that are more restrictive than the tax rules may appear to place a firm at a competitive disadvantage, corporate-sponsored retirement plans often use them to protect the plan from failing to make minimum required distributions and, hence, fall out of compliance.  In a majority of instances, the offending provisions are so deeply imbedded in the plan’s disclosure documents that innocent participants hardly ever stumble onto them.   Even knowledgeable practitioners can overlook these minute snags.  It is possible that the more streamlined rules under the final regulations may bring forth a positive change, but the author has serious reservations that plan administrators will ever want to shoulder responsibility for fulfilling required distributions over fifty or sixty years to a participant’s grandchild.   

2.                  On a more positive note, IRA’s and §403(b) plans are usually quick to incorporate all the stretch-out provisions of the tax rules in order to encourage the retention of assets.  In many cases, the final regulations allow longer tax-deferred accumulation by beneficiaries than under the original 1987 rules or even the 2001 proposed regulations.  Do not be surprised if you soon hear IRA and §403(b) providers trumpeting the elongated stretch-out aspects of the final regulations.  While it is true that the final regulations do impose an additional reporting requirement on IRA providers beginning in 2003, the extra burden will not be a deterrent.  By the way, those reports will only be necessary during the lifetime of an IRA owner.  Beneficiary distribution accounts are exempt.  

3.                  The intertwining alternatives that deal with minimum required distributions following a participant’s post-RBD death seem to outnumber the freeways in Los Angeles.  If not, they certainly match the twists and turns of the latter.  Rather than attempt to describe those intricacies in outline format, it is far more effective for readers to view them on flow charts.  Those charts, located on Tables 25A and 25B, provide a map that will help beneficiaries navigate though the maze.  To effectively use the tables you must first know if the sole Designated Beneficiary is the participant’s spouse.  If so, turn to Table 25A.  In all other cases, begin by perusing Table 25B.  The black tab near the top left corner of each table will also help guide you to the proper one.  Once on the correct table, start at the oval identifying the facts and circumstances that match your case and then follow the arrows.       

C.                Corporate-sponsored retirement plans will soon amend their provisions to comply with the final regulations.  No doubt, IRA and §403(b) plan providers will follow suit.  Hopefully, all of them will embrace the generous latitude provided for DISTRIBUTIONS DURING A PARTICIPANT’S LIFETIME.  However, §1.401(a)(9)-1, A-3(b) does allow those plans to be more restrictive.  An explanation of the final regulations dealing with lifetime distributions can be found earlier in this document under a heading "What Is The Minimum Annual Distribution During Your Lifetime?"  The application of those steps is illustrated on Table 21A.  [Note:  IRC §408A(c)(5)(A) exempts Roth IRA’s from required distributions during the owner’s lifetime.] 

Conclusions   

The text on the preceding pages provides a reasonable primer to use when beginning to explore the financial and estate planning implications of the minimum distribution rules under IRC §401(a)(9) and the final regulations published by the Internal Revenue Service on April 17, 2002.  The 2002 Planning Pointers listed on another page of this web site provide important reminders to individual participants, their beneficiaries and planning professionals.  Further insights will soon be available on another page of this web site entitled “2002 Practical Considerations”.  Once posted, that page will furnish a detailed explanation of Tables 26 through 29C.   

Other Resources 

Serious students need to go far beyond the limited areas addressed by the author.  The final regulations provide a detailed map of the terrain that must be traversed.  An excellent interpretation of the minute details on that “map” is available in the 6th edition 2006 of Life and Death Planning For Retirement Benefits by Natalie B. Choate, Esq.  Ms. Choate has a tremendous depth of knowledge in this subject.  Her telephone number in Boston is (617) 951-8817.  Her web site is www.ataxplan.com.   That site offers an eight-page summary of the final regulations and an online system by which readers can obtain printed updates of various chapters in her book.  Another grand master of this subject is Noel C. Ice, Esq. in Fort Worth, Texas.  His office telephone number is (817) 877-2885.  His web site at www.trustsandestates.net is full of authoritative commentary on this and other subjects.   Both Ms. Choate and Mr. Ice provide forms and sample language to assist members of the legal profession.    

Practitioners looking for software are encouraged to contact Net Worth Strategies in Bend, Oregon.  The firm’s web site is www.networthstrategies.com.  Their excellent MRD Determinator program was created by a good friend, Guerdon T. Ely, CFP.   The extremely comprehensive and user-friendly input wizard built into MRD Determinator produces accurate required distributions amounts under any set of circumstances.   Included too are text explanations along with detailed descriptions and applicable citations.

Another vendor worth considering is Brentmark Software.  Their telephone in Winter Park, Florida is (800) 879-6665.   The company’s web site is www.brentmark.com.  Ask Brentmark to send you a free demonstration disk for the “Pension & Roth IRA Analyzer” as well as their “Minimum Distributions Calculator.”  Those programs offer a viable means to deal with many routine situations.  Unfortunately, they do not provide sufficient flexibility to conduct advanced planning unless the user is willing to enter an enormous amount of hand-calculated data.

If you have read to this point in the text, be sure to peruse the 2002 Planning Pointers on another page of this web site.   They apply the Rules of the Road spelled out above to everyday circumstances confronting both individual participants and planning professionals.

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