Estate and Tax Planning
Spring 2001

IRS SIMPLIFIES AND LIBERALIZES RULES ON REQUIRED MINIMUM DISTRIBUTIONS

On January 11, 2001, the IRS issued proposed regulations that greatly simplify the distribution and beneficiary rules applicable to qualified plans, individual retirement accounts, ("IRAs"), and certain other tax-favored retirement vehicles. The new regulations present two important tax planning opportunities: First, most taxpayers will be able to defer a greater amount of retirement income over a longer period of time than under the old rules. Second, taxpayers and their families will have greater flexibility in planning for the timing, amounts and recipients of retirement distributions both during and after the taxpayer's life.

As a general rule, the Internal Revenue Code requires taxpayers to begin receiving annual distributions from their retirement plans no later than their "required beginning date" -- generally April 1st of the year following the calendar year in which the taxpayer attains age 70-1/2. Under the old rules; the smallest amount a taxpayer could receive each year (the "minimum required distribution," or MRD) depended upon certain irrevocable elections that had to be made by the taxpayer by the required beginning date. For instance, the taxpayer could elect to compute the MRD based on the "recalculation of life-expectancy" method (which requires annual recalculation) or the "term-certain" method (which requires no annual recalculation). If the taxpayer had sufficient other income sources, the taxpayer would typically elect the recalculation of life-expectancy method because it often produced the smallest possible MRD payable over the longest possible payout period. If the taxpayer also elected to designate an individual survivor beneficiary, such as a spouse or child, the MRD could be further reduced and the payout rate further extended over the joint life expectancy of the taxpayer and the designated survivor beneficiary. Once made, however, these elections effectively "locked in" the payout schedule of the MRDs to the taxpayer during his or her life.

In response to the continuing confusion among taxpayers and their advisors in making these elections, the new regulations streamline the method for determining a taxpayer's MRD. A uniform minimum distribution table will now permit a taxpayer to determine his or her MRD for a given year based on his or her age and the account balance as of December 31 of that year. In calculating the MRDs during the taxpayer's life, the age of a designated beneficiary is no longer relevant and the application of the new table will give most taxpayers a smaller MRD than provided under the old rules. The bottom line benefit is that spreading out a taxpayer's MRDs could reduce the immediate income tax bite imposed on retirement distributions, allow for continued tax-deferred growth of the retirement assets during the taxpayer's life, and leave more property for distribution to the taxpayer's heirs.

The new regulations also liberalize the rules for when taxpayers must designate a plan beneficiary, affording taxpayers and their families far more flexibility in planning for the timing and amounts of retirement distributions both during the taxpayer's life and after his or her death. Under the old rules, the taxpayer's election of a survivor beneficiary permanently established the MRD, and changing the designation thereafter to favor a younger beneficiary would not result in a reduced MRD. Under the new rules, the survivor beneficiary will receive MRDs after the taxpayer's death based on his or her own life-expectancy and need not be identified until December 31 of the year following the year of the taxpayer's death. This allows a taxpayer to change the designated beneficiary from time to time and at any point prior to death without adverse tax consequences because the beneficiary's age is now irrelevant for purposes of calculating the taxpayer's MRD during lifetime.

The new December 31 deadline also presents useful post-mortem planning options; For example, if the survivor beneficiary designated by the deceased taxpayer does not need the retirement assets and/or has a short life-expectancy, the beneficiary may be in a position to disclaim his or her right to inherit the retirement assets in favor of an alternate beneficiary with a longer life-expectancy. The resulting benefit is that the alternate beneficiary would be able to receive smaller annual MRDs over a longer period of years. Presumably, any such disclaimer would have to comply with the regular tax law requirements for disclaimers under Section 2518 of the Internal Revenue Code and any applicable state law requirements to avoid adverse transfer tax consequences.

Assume a taxpayer dies having designated his son and granddaughter as his plan beneficiaries in equal shares. If the son actually collects his full one-half share of the account outright before December 31 of the year following the year of the taxpayer's death, the new rules will disregard him as a designated beneficiary for purposes of determining the MRD which the granddaughter will receive. Only the granddaughter's longer life-expectancy will be taken into account and, consequently, she will receive smaller MRDs.

The new rules also present opportunities when multiple beneficiaries are designated. Under the old rules, if multiple beneficiaries were designated, all beneficiaries had to take distributions based on the life expectancy of the oldest beneficiary. The new rules allow the beneficiaries to elect to split the retirement plan into separate accounts, enabling each beneficiary to take distributions based on his or her own individual life-expectancy.

The new rules come as a welcome response to the high level of taxpayer error and confusion arising from the old rules and seek to prevent taxpayers from inadvertently "opting into" disastrous income tax consequences. At the same time, the IRS will require strict adherence to annual reporting requirements on the part of plan sponsors and IRA trustees.

Special Points

Although the age of a designated beneficiary is now irrelevant for purposes of computing a taxpayer's MRD, the new rules provide one advantageous exception: If the taxpayer designates his or her spouse as the beneficiary and the spouse is more than ten years younger than the taxpayer, the new rules will permit a calculation which results in an even longer payout period. In all other cases, the new uniform table will impose a payout period that assumes a maximum age difference of 10 years between the taxpayer and the designated beneficiary.

The new rules are contained in proposed regulations and are not likely to become final until January 1, 2002, after public hearings and other reviews. Nevertheless, the IRS will allow taxpayers to rely on the new rules in calculating their MRD for 2001. To the extent the final regulations are more restrictive than the proposed regulations, however, they will be issued without retroactive effect. (Caveat: The new rules are not applicable for purposes of calculating a taxpayer's year 2000 MRD that is eligible for deferral until April, 2001.)

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