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© George H. Coughlin II 2002 All Rights Reserved Return to Home Page |
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"Final" Minimum Distribution Rules: Planning
Opportunities Abound But Quicksand Remains For The Unwary 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.
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. DisclaimerGeorge 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
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). 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? 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)] 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
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.
Table of Contents | Test Your Knowledge | Quiz Your Advisor | 2002 Technical Terms | 2002 Rules of the Road | 2002 Planning Pointers | 2002 Postmortem Flow Charts | 2002 Illustrative Graphs
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