Quicksand Remains

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


Financial and Estate Planning Implications of the

"Final" Minimum Distribution Rules:

Planning Opportunities Abound But Quicksand Remains For The Unwary

 George H. Coughlin II, CFP

 Introductory Remarks

Yes indeed, the Internal Revenue Service has been hard at work.  On April 17, 2002 it published final regulations that provide an abundance of well-marked routes to follow when planning required distributions from IRA’s, qualified retirement plans and §403(b) plans.  The Service even managed to clarify most, but not all, of the ambiguities that existed in the 2001 reproposed regulations.  Finally, Marjorie Hoffman, Cathy Vohs and their respective staffs at the IRS and Department of Treasury threw in a surprise bonus -- a new set of life expectancy tables.  Granted, the text of the final regulations covers approximately 104 printed pages compared to only 39 pages for the original 1987 proposed edition, but the results are worthwhile.      

Most taxpayers mistakenly believe that the required distribution rules spelled out in §401(a)(9) of the Internal Revenue Code only apply to lifetime distributions beginning at age 70½.   Failure to consider the numerous financial and estate planning implications of those tax provisions can lead to unpleasant complications during retirement and substantial financial loss for survivors. Everyone with assets in a retirement plan, regardless of their age, needs to have a reasonable understanding of minimum required distributions. In certain circumstances, that understanding can be more valuable than the selection of a prudent investment.

Unfortunately, the complexity associated with this area of the tax law intimidates many taxpayers. If you readily identify with that group, rest assured you have plenty of company. Even competent tax practitioners often miss the financial and estate planning implications associated with required distributions although they understand how to apply those rules when preparing a tax return.

 

The following questions provide a quick way to gauge your knowledge of this subject.

 

  1. Explain the difference between a Designated Beneficiary and a recipient named on a beneficiary designation form?  [§1.401(a)(9)-4, A-1]
  1. For purposes of required distributions paid to a beneficiary in 2003 and subsequent years, what action must be taken in every case that involves the death of a plan participant before January 1, 2003? [§1.401(a)(9)-1, A-2(b)(1)] 
  1. What is the deadline to establish separate accounts that allow the beneficiary of each respective separate account to use his or her own life expectancy when computing the maximum stretch-out potential?    [§1.401(a)(9)-8, A-3]
  1. List the four requisites a revocable trust must fulfill in order for it to serve as a suitable beneficiary of an IRA, TSA or qualified retirement plan?  What is the deadline for satisfying each of those requirements?  [§1.401(a)(9)-4, A-5(b)] 
  1. How do you determine the applicable distribution period for required distributions following a participant’s post-RBD death if the account has no Designated Beneficiary?  [§1.401(a)(9)-5, A-5(c)(3)] 
  1. If a QTIP trust is used as a beneficiary for a qualified plan, what resource document spells out the guidelines that such a trust must follow in order to qualify for the marital deduction and also satisfy the minimum distribution rules? 

If you feel hesitant about your answers to these questions, seek assistance from a knowledgeable tax professional. You will know that person truly understands this subject if he or she can readily answer the same questions. If you receive a vague or evasive response, please contact another professional. The decisions you must make are too important to rely on guesswork or incompetent advice.

The 2002 Rules of the Road” and “2002 Assorted Planning Pointers” that follow this introduction provide technical assistance for those wishing to improve their understanding or research a specific question. Please note, however, that this document should not be used as a substitute for the knowledge and insights available from a well-trained professional who routinely deals with these issues. Readers who undertake their own planning are urged to double-check their conclusions by obtaining a professional opinion before implementing those plans. In addition, please peruse the following disclaimer. 

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 New 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 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 70½.  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 70½. 

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 70½.  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 as well as a 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 70½, 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 71½.  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 71½.  [§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 70½.  (For more details, please refer to the discussion on page 6 entitled “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 70½.  (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”.  These 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 70½.  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 70½, 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 70½.  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 70½ 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 new 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 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 Assorted Planning Pointers" listed below provide important reminders to individual participants, their beneficiaries and planning professionals.  Further insights will soon be available on the web page 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. 

 

2002 Assorted Planning Pointers

The following planning pointers illustrate various required distribution issues encountered in typical circumstances.  The author welcomes suggested additions. 

A.      Always have a beneficiary designation on file with the plan administrator regardless of the age of the participant.  Whenever possible, the named beneficiary should also qualify as a Designated Beneficiary so there will be added stretch-out potential for the postmortem required distributions.  This is especially important if a participant dies before the required beginning date.  Under those circumstances, the absence of a Designated Beneficiary will force a complete distribution of the entire account by the end of the fifth year following the year the participant dies.  (See item "T" below for inportant information if a minor is named as a beneficiary.)    

B.      If a non-DB is a beneficiary of an income or remainder interest as of September 30 of the year following the participant’s death, NONE of the beneficiaries will be treated as a Designated Beneficiary, even if the rest of the named beneficiaries would otherwise qualify as DB’s.  This is true under all circumstances controlled by §401(a)(9).  Please remember, however, that each separate account is independent of all others when the time comes to determine its designated beneficiaries.  A further explanation of this point appears under the heading “Separate Accounts” in the “Technical Terms” section of this manuscript.   See item “E” below for examples of beneficiaries that do not qualify as DB’s and an explanation of the implications.  [§1.401(a)(9)-4, A-3 & §1.401(a)(9)-8, A-2(a)(2)]  

C.     When a surviving spouse opens a spousal rollover IRA, be sure to simultaneously select beneficiaries that qualify as Designated Beneficiaries.  The reasons parallel those stated in items “A” and “B” above. The same recommendation holds true when a non-spouse beneficiary of a pension, profit sharing or stock bonus plan (QRP's) executes a postmortem trustee-to-trustee transfer of a QRP into an inherited IRA.  (See "Can the Qualified Plan Limit Your Planning Options?" in the 2002 Rules of the Road and item "G" below.)  

D.     Whenever possible, a secondary and tertiary beneficiary should be named for each account in case the primary beneficiary predeceases the participant.   In addition, well-planned contingent beneficiary designations will help facilitate postmortem planning by beneficiaries who might wish to execute disclaimers.  (See item “J” for a discussion of qualified disclaimers.) 

E.      Extra care should be taken if you are considering using an estate, charity, partnership or corporation as a beneficiary.  Those four entities do not qualify as a Designated Beneficiary.  (See item “B”.)  If a non-DB that is entitled to a pecuniary interest from a qualified retirement plan, IRA or §403(b) plan fails to remove its share of the account prior to September 30 of the year following the year of the participant’s death, the other beneficiaries will lose valuable stretch-out potential.  One way to avoid such a trap is to provide the non-DB with a fractional or percentage interest.  By using this alternate means of allocation, it is permissible to establish separate accounts by December 31 of the year following the year of death and, hence, use the life expectancy of the oldest DB of each respective separate share when computing required distributions -- even though the non-DB fails to receive its fractional or percentage interest before the Designation Date.  This issue is important regardless of the participant’s age.  (See items “B”, “H” and “P”.) 

F.      Every case involving a participant that died before January 1, 2003 should be reviewed to make sure that MRD’s for years 2003 and later are based on the life expectancy of the correct calculation-DB as well as the new single life expectancy table in the final regulations.   For a further discussion of this very important point, please refer to the Redesignation/Reconstruction Rule in the “Technical Terms” section of the 2002 Rules of the Road.        

G.    Unlike a spouse who is named as beneficiary of a pension, profit sharing or stock bonus plan (QRP's), a non-spouse beneficiary of such plans is not allowed to roll over the QRP into an IRA in their own name, à la a spousal rollover IRA.  Effective for distributions made after 2006, 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.    

H.     The spousal exception to the five-year rule in pre-RBD death cases is prohibited if the spouse is not the sole primary beneficiary of a separate account.  Assuming the other beneficiaries qualify as DB’s, the spouse and the other beneficiaries could use the general exception to the five-year rule -- provided it is permitted under the plan provisions.   If one or more of the other primary beneficiaries do not meet the DB requirements, ALL beneficiaries must use the five-year rule.  (See item “B”.)  [§1.401(a)(9)-5, A-7(c)(3), Example 1 and §1.401(a)(9)-8, A-2(a)(2)]   

I.          Letter Ruling 9237038 points out that an EXECUTOR for a surviving spouse that dies before making an election to treat the first deceased spouse’s IRA as his or her own IRA cannot make that election for the deceased surviving spouse.  In other words, an executor for the second to die cannot carry out a spousal rollover if the surviving marriage partner fails to do so before his or her own death.  Even under the more generous rules of the final regulations, this could result in the loss of valuable tax deferral.  Had the rollover to the spousal IRA taken place, the surviving spouse would likely have specified the couple’s children as his or her own beneficiaries.  Following the death of the surviving spouse, the beneficiaries of that spousal rollover IRA would be eligible to compute MRD’s using the life expectancy of the oldest DB.  Without a spousal rollover, the ultimate recipients of the account, most likely the couple’s children, will be forced to use the considerably shorter single life expectancy of the second deceased parent when computing required distributions.  [§1.401(a)(9)-4, A-4(c) and §1.401(a)(9)-5, A-5]  There is one possible remedy if the non-participant spouse beneficiary happens to die within nine months of the participant.  Provided state law permits, the executor for the surviving spouse can disclaim that second decedent’s rights to the qualified plan benefits.  Such action effectively returns control of the assets to the participant’s own beneficiary election form.  If the couple’s children are listed as contingent beneficiaries on that form, the qualified plan assets will pass directly to them.  As a minimum, the latter will also be able to use the oldest sibling’s life expectancy to stretch out required distributions.  

J.       The final regulations clearly establish the Service’s willingness to recognize disclaimers for purposes of required distributions under IRC §401(a)(9).  [§1.401(a)(9)-4, A-4(a)]  Hence, a primary beneficiary that executes a qualified disclaimer by the nine-month deadline following the participant’s death will not be considered a beneficiary when it comes time to determine DB’s on the designation date.  This technique creates a number of postmortem planning opportunities.  Unfortunately, most beneficiary election forms provided by qualified retirement plans, IRA’s and TSA’s do not readily accommodate disclaimers if several individuals (children) are listed as primary beneficiaries.  In the event one of the latter executes a qualified disclaimer, his or her share is usually divided among the other primary beneficiaries (siblings).  This occurs even if the participant named contingent beneficiaries (grandchildren).  In order to overcome this dilemma, planning professionals need to encourage 401(k) administrators, IRA custodians and TSA trustees to add language to their beneficiary forms that will allow participants to direct benefits to specific contingent beneficiaries if a particular primary beneficiary elects to disclaim his or her rights.  

K.     If a trust is to be used as a beneficiary for a qualified plan, do so only after a thorough review of the distribution rules and how they interact with the other estate planning needs.  Pay special attention to the possibility that a trust may contain language that prevents it from qualifying under the Designated Beneficiary Rules.  Finally, be sure to deliver a copy of the trust instrument, or the substitute documentation specified in §1.401(a)(9)-4, A-6 of the final regulations, in a timely manner to the plan administrator.   For more details, peruse the “Trust As Beneficiary” discussion in the “Technical Terms” section of the 2002 Rules of the Road.  Then be sure to review the language of §1.401(a)(9)-4, A-5 and A-6 in the final regulations.  Lastly, be sure to peruse Chapter 6 in the 6th edition 2006 of Natalie Choate's Life and Death Planning for Retirement Benefits.      

L.      If a QTIP trust is to be used as a beneficiary for qualified plans, peruse Rev. Rul. 2000-2.  The ruling provides specific guidance to insure that such a trust agreement qualifies for the martial deduction while simultaneously satisfying the rules for minimum annual withdrawals from qualified plans.  Please note that the executor needs to make the QTIP election under §2056(b)(7) for BOTH the qualified retirement plan or IRA as well as the trust that is named as its beneficiary.  Remember too, a QTIP trust must adhere to all the normal distribution rules for trusts.  (See item "K".)   

M.     Although an irrevocable trust may be named as the beneficiary of a qualified plan, it is permissible to change to a new irrevocable trust as often as necessary to facilitate alterations in the estate plan.  

N.     Married participants often select their spouse as the primary beneficiary for qualified plans and specify a family trust as the contingent.  However, it may cause problems if the non-participant spouse wishes to disclaim all or a portion of the plan benefits.  (See item “J”.)  While the disclaimer may be qualified under I.R.C. §2518, one portion (the survivor's trust) of the typical family trust that is named as the contingent beneficiary remains revocable after the death of the first trustor.  Regulation §1.401(a)(9)-4, A-5(b)(2) states that a trust named as the beneficiary of a retirement plan or IRA must become irrevocable on or before the participant's death to satisfy the Designated Beneficiary Rules.  Failure to achieve DB status can severely limit the stretch-out potential of distributions to a living trust regardless of the participant’s age at death.  Of particular concern is the five-year rule described in §401(a)(9)(B)(ii) when the participant dies before his or her required beginning date.  Please note that some commentators feel that the grantor trust provisions spelled out in IRC §671-679 allow the survivor's trust under these circumstances to overcome the irrevocability clause of the final regulations mentioned above.  In fact, at least one private letter ruling (LTR 199903050) appears to embrace this conclusion.  However, the final regulations mention no exceptions to §1.401(a)(9)-4, A-5(b)(2).   Fortunately, there is one sure means by which a plan participant can preserve his or her survivors' right to use the general exception under §401(a)(9)(B)(iii) when a trust is named as the contingent beneficiary and the surviving spouse is the primary beneficiary.  To do so, make the contingent beneficiary the portion of the family trust that becomes irrevocable upon death of the plan participant -- not the whole family trust.  That is to say, be specific by naming the bypass, credit shelter or QTIP trust as the contingent beneficiary.  [§1.401-(a)(9)-4, A-5]  

O.     If the rights to receive plan assets pass to a trust upon the death of a participant, the required distributions will eventually exceed the income earnings of the qualified plan.  From then on, the trust will be forced to recognize the principal portion of the required distributions as taxable income to the trust.  If the trust in turn passes out that principal to the income beneficiary to avoid a potential 35.0% Federal tax rate, the basic purpose of the trust may be compromised.  Imagine the uproar that would emanate from the beneficiary of a remainder interest in a bypass or QTIP trust if the surviving spouse, in a second marriage situation, started receiving principal.   If a trust needs to be the beneficiary for a qualified plan, be sure that the trust defines income and principal as the two words apply to distributions from a qualified plan.  This last tip may also help overcome the artificial assumption built into many state uniform principal and income acts that limit income to a very small percentage (only 10% in California) of a required distribution from qualified plans.   

P.      Beneficiaries of the remainder interest in a bypass or credit shelter trust as well as a QTIP trust may have to wait for the death of the income beneficiary, usually the surviving spouse, before receiving benefits, but that is only a timing issue.   The remainder persons will receive something, albeit delayed.  Therefore, the life expectancy of the remainder beneficiaries must be considered when deciding the Designated Beneficiary with the shortest life expectancy.  [§1.401(a)(9)-5, A-7(c), Example 2(iii)]  Remember that if a charity or other non-DB has a remainder interest, you have “non-DB status”.  (See items “B” and “E”.)   

Q.     Following the death of a participant, a spouse or non-spouse DB may name a beneficiary of his/her own to receive the balance of the participant's account if the original DB dies before withdrawing all the funds.  The beneficiary's action does not impact the required distribution calculations.  For a prolonged period, many IRA custodians and trustees felt that only a surviving spouse was allowed to name a subsequent beneficiary.   Fortunately, §1.401(a)(9)-4, A-4(c) and §1.401(a)(9)-5, A-7(c)(2) of the final regulations grant the same privilege to non-spouse DB's.     

R.     A surviving spouse that is the sole primary beneficiary of a decedent’s account may decide NOT to elect to treat the account as the spouse's own.   In essence, the survivor maintains his or her status as beneficiary of the decedent's account.  This is possible even if the surviving spouse rolls over the decedent's qualified retirement plan into an IRA or transfers the decedent's IRA directly to a new IRA.  [§1.408-8, A-7]  By remaining the beneficiary of the account, rather than becoming its owner, the survivor is permitted to postpone required distributions until the year the deceased participant would have attained age 70½.  Using this Spousal Exception under §401(a)(9)(B)(iv) to delay mandatory withdrawals is often considered when the surviving spouse is younger than age 59½ because the 10% Federal excise tax on pre-59½ distributions will NOT apply if he or she taps the account.  In contrast, the excise tax will apply to early withdrawals from a spousal rollover account.  Unfortunately, a surviving spouse that has avoided the 10% excise tax on early distributions because of the exclusion under IRC §72(t)(2)(A)(ii) may lose the right to subsequently transfer the deceased participant’s qualified plan to a spousal rollover IRA of his/her own.  (See LTR’s 9418034 and 9608042 but be sure to contrast them with LTR 200110033.)  Please keep in mind that when required distributions finally begin under IRC §401(a)(9)(B)(iv), minimum withdrawals must be computed using the surviving spouse’s single life expectancy on an attained age basis, rather than the more favorable values found on the Uniform Lifetime Table that would apply if the surviving spouse were to treat the account as his or her own.  During the survivor’s lifetime, that differential could produce a significant disadvantage in the form of larger taxable distributions.  [§1.401(a)(9)-5, A-5(c)(2)]  The Spousal Exception is also detrimental if the survivor dies after commencement of required withdrawals.  Under those circumstances, the final regulations force the ultimate beneficiaries (probably the couple’s children) to complete those required distributions based on the fixed-period single life expectancy of the surviving spouse established on his or her birthday in the year of death.  [§1.401(a)(9)-5, A-5]  That new rule effectively compels the children to greatly accelerate withdrawals and, hence, forego the tremendous stretch-out potential that would have been available to them as beneficiaries of an account that the surviving spouse elected to treat as his or her own.   

S.      The final regulations list the life expectancy rule as the default method when participants die before the RBD – provided there is a Designated Beneficiary.  This change may prevent non-spouse DB’s from being forced to adhere to the Five-Year Rule if they forget to withdraw the first required distribution by December 31 of the year after the participant’s death.  Unfortunately, there is no escape from that quicksand if a qualified plan mandates the Five-Year Rule or uses it as its default in the event a beneficiary fails to make an election to the contrary.  However, rescue is possible in cases where a plan stipulates that a non-spouse DB must use the General Exception to the Five-Year Rule, lists that exception as the plan’s default if the DB forgets to make an election to use it, or is silent as to what method must be followed if no election is made.  In each of the latter three scenarios, the DB may escape from the clutches of the Five-Year Rule by switching to the General Exception under §401(a)(9)(B)(iii).  To accomplish that change, any amounts that would have been required to be distributed under the General Exception for all distribution calendar years before 2004 must be distributed by the earlier of December 31, 2003 or the end of the fifth year following the year of the participant’s death.  (See §1.401(a)(9)-3, A-4, §1.401(a)(9)-1, A-2(b)(2) and Table 24 on this web site. 

T.  If a participant wishes to name a minor as beneficiary of his or her qualified retirement plan (QRP), individual retirement account or §403(b) tax sheltered annuity (TSA) contract, difficulties often arise because state laws restrict the transfer of assets to anyone that has not yet attained a certain age.  While a minor can be listed as a beneficiary, IRA custodians and plan administrators will not distribute assets directly to a minor.  They will distribute assets to a court-appointed legal guardian of a minor or the custodian of an account established for a minor under the Uniform Transfers to Minors Act.  In addition, IRA custodians and QRP administrators are happy to make postmortem distributions to the trustee of a trust for the benefit of a minor.  While the options outlined in the two preceding sentences may appear to resolve the dilemma, each introduces its own list of complications and considerations that are beyond the scope of this Planning Pointer.  Fortunately, an in-depth discussion of this topic is available in ¶6.3.12 of the 6th edition 2006 of Natalie Choate's Life and Death Planning for Retirement Benefits

U.   If a participant dies on or after his or her required beginning date, the required distribution for the year of death (YOD) must be taken on or before December 31 of that same year.  The Code and Regulations do not provide a grace period for the participant's beneficiaries.  That is to say, the beneficiaries need to withdraw the required distribution by the same deadline the participant would face if he or she were alive.  The year-of-death's required distribution is computed as if the participant were alive throughout the entire year -- even if he or she died on January 1.  If a participant withdrew a portion of the year's required distribution prior to dying sometime during that year, the beneficiaries must withdraw the remainder of the required distribution by year's end.  Although the remainder of the required distribution belongs to the beneficiaries, it is includable in the decedent's estate and represents income in respect of a decedent (IRD).  Note too that 100% of the YOD's required distribution must be taken before effecting a spousal rollover or trustee-to-trustee transfer of a qualified retirement plan by a non-spouse beneficiary to an inherited IRA.  

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