Tax and Financial News for August 2001
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The New IRA Distribution Rules – This is Simple?
In January 2001, the IRS proposed new IRA distribution regulations that remind us a lot of Microsoft’s Windows 95 launch. Much like Windows 95, the new regulations do appear easier to navigate and more user friendly. Also like Windows 95, the new rules are still complex and will require considerable thought on how best to use them. Nonetheless, just as with Windows 95, the new IRA distribution regulations are a considerable step forward in helping the taxpayer manage their retirement distributions.
The new regulations are to take effect for distributions made beginning in January 2002. Taxpayers can, however, apply those rules to distributions in 2001. Additionally, be aware that these rules apply only to IRAs. In order to apply these rules to your employer sponsored plan, the employer must amend their plans following IRS-adopted model language.
What is a Required Minimum Distribution?
A Required Minimum Distribution (RMD) is the amount a taxpayer has to withdraw from their IRA each year and it is based on his or her life expectancy. When the distributions must start depends on the type of account, if the individual is still employed by the plan sponsor and if the person is an owner-employee of the plan sponsor.
Under the 1987 proposed regulations, the distribution period was dependent on whether there were designated beneficiaries or not. If there were one or more beneficiaries, the joint life expectancy of the owner and the beneficiaries could be used. The individual also had to decide whether to recalculate his or her life expectancy each year.
The new rules have simplified the decision making in this area. Unless the sole designated beneficiary is a spouse who is more than 10 years younger than the IRA owner, the new tables assume a beneficiary is ten years younger than the owner. Hence, the joint life expectancy of a 70-year-old owner would assume the beneficiary is 60. For an 80-year-old owner, the beneficiary would be assumed to be 70 years old.
Additionally, the new regulations do not require an individual to name the designated beneficiary prior to beginning distributions nor does a determination have to be made as to whether the distribution amount will be recalculated every year. In most instances, the IRA owner will be able to revise the distribution amount annually based on their age and the balance in the account at the end of the prior year.
A beneficiary may also be determined up to the end of the calendar year following the year in which the taxpayer dies. This allows changes in beneficiaries to be made without increasing the RMD. The ability to change the RMD based on a designated beneficiary disclaiming part of their inheritance or being cashed out will also allow flexibility in determining the extent of annual required distributions by the remaining heirs.
So, when do I have to start taking distributions?
Assuming you have retired, you are required to start taking the RMD by April 1of the calendar year following the calendar year in which you reach age 70 1/2. If you are still working at age 70 1/2 and are not a 5% owner, you can defer the distribution until the April 1 of the calendar year following the calendar year in which you retire from the employer sponsoring the plan.
Five percent owners may not defer the distributions beyond April 1 of the calendar year following the calendar year in which they retire. If you are a five percent or greater owner, be certain to observe this rule when the time comes or you may face substantial penalties.
How long do I have to distribute the balance of my account?
The number of years you use in determining the RMD depends on your age when you start. The age of the beneficiary is of no account assuming 1) your spouse is not the sole beneficiary and 2) the distributions begin before you die. In this case, you use the standard tables provided by the IRS. If your spouse is the sole beneficiary and is more than ten years younger, then you must us the joint life expectancy tables supplied by the IRS.
If you die before the required start date, then your heirs/beneficiaries have a choice of two methods to compute the RMD - the five-year rule or the life expectancy rule. The method used depends on whether you have a designated beneficiary and whether your designated beneficiary is your spouse.
Under the five-year rule, the entire balance of your account must be distributed by the fifth anniversary of your death, regardless of who receives the distribution. This method is required when there is no designated beneficiary. Be aware that your estate is not eligible to be treated as a designated beneficiary. Also, a trust is not considered a designated beneficiary, but if the trust is properly designed, the beneficiaries of the trust may qualify.
The life expectancy rule is what it sounds like. The distributions will be calculated using the life expectancy of the beneficiaries.
If the sole beneficiary is your surviving spouse, then your spouse basically steps into the your shoes. This means your spouse will either have to start the RMD by the end of the calendar year immediately following your death or the end of the calendar year in which you would have reached age 70 1/2. If your spouse dies after you, but before distributions are to begin, the life expectancy and five year rules are used based on your spouses' age.
If your spouse is not the designated beneficiary, then distributions must begin by the end of the calendar year following your death. This also applies if your spouse and another person are the designated beneficiaries. When the life expectancy rule is used and there is more than one designated beneficiary, the age of the oldest beneficiary is used in computing the RMD for all beneficiaries.
One other point to consider is if your surviving spouse elects to treat the IRA as his or her own. In this case, the timing of distributions will depend on the spouse's age, but the spouse must be the sole beneficiary and must have unlimited withdrawal rights. This requirement can't be satisfied if the beneficiary of the IRA is a trust, even if your spouse is the only beneficiary.
Do I have to take money out of each IRA?
If you have more than one IRA, you must determine the RMD separately for each IRA. However, you can draw the money out of only one account if you desire. This can be useful when you have one account earning a greater return than another. If you have several IRAs you hold as a beneficiary of a decedent, you would compute the RMD separately for each IRA, but you can withdraw the RMD out of any one those IRAs. The general rule, however, is you must treat IRAs from different decedents as separate accounts and, therefore, withdraw based on where you inherited the money.
For example, assume Jeff is the beneficiary of six IRAs. He received IRA 1 and IRA 2 from Bob, IRA 3 and IRA 4 from Amy and IRA 5 and IRA 6 from Stephen. Assume the RMDs are as follows: IRA 1 - $100; IRA 2 - $50; IRA 3 - $65; IRA 4 - $75; IRA 5 - $95; and IRA 6 - $105. Jeff can elect to take the RMDs from each account, or he can take $150 from either IRA 1 or 2, $140 from either IRA 3 or 4 and $200 from either IRA 5 or 6.
Distributions from 403(b) contracts or Roth IRAs cannot be used to satisfy the RMD requirements.
Conclusion
The IRS has taken great pains to make the RMD rules simpler. The new tables are easier to understand and the distributions are generally lower under the new regulations. However, considerable care is still needed to properly apply the rules. The increased assets remaining in IRA accounts can, in some circumstances, be a detriment rather than a boon and simple reliance on regulations without a review of the underlying plan documents could cause some bad surprises.
Don't let unwelcome surprises harm you or your loved ones. Give us a call today and let us review your situation and minimize the chance you or your family could be caught by surprise.
Have a great August!
The new regulations are to take effect for distributions made beginning in January 2002. Taxpayers can, however, apply those rules to distributions in 2001. Additionally, be aware that these rules apply only to IRAs. In order to apply these rules to your employer sponsored plan, the employer must amend their plans following IRS-adopted model language.
What is a Required Minimum Distribution?
A Required Minimum Distribution (RMD) is the amount a taxpayer has to withdraw from their IRA each year and it is based on his or her life expectancy. When the distributions must start depends on the type of account, if the individual is still employed by the plan sponsor and if the person is an owner-employee of the plan sponsor.
Under the 1987 proposed regulations, the distribution period was dependent on whether there were designated beneficiaries or not. If there were one or more beneficiaries, the joint life expectancy of the owner and the beneficiaries could be used. The individual also had to decide whether to recalculate his or her life expectancy each year.
The new rules have simplified the decision making in this area. Unless the sole designated beneficiary is a spouse who is more than 10 years younger than the IRA owner, the new tables assume a beneficiary is ten years younger than the owner. Hence, the joint life expectancy of a 70-year-old owner would assume the beneficiary is 60. For an 80-year-old owner, the beneficiary would be assumed to be 70 years old.
Additionally, the new regulations do not require an individual to name the designated beneficiary prior to beginning distributions nor does a determination have to be made as to whether the distribution amount will be recalculated every year. In most instances, the IRA owner will be able to revise the distribution amount annually based on their age and the balance in the account at the end of the prior year.
A beneficiary may also be determined up to the end of the calendar year following the year in which the taxpayer dies. This allows changes in beneficiaries to be made without increasing the RMD. The ability to change the RMD based on a designated beneficiary disclaiming part of their inheritance or being cashed out will also allow flexibility in determining the extent of annual required distributions by the remaining heirs.
So, when do I have to start taking distributions?
Assuming you have retired, you are required to start taking the RMD by April 1of the calendar year following the calendar year in which you reach age 70 1/2. If you are still working at age 70 1/2 and are not a 5% owner, you can defer the distribution until the April 1 of the calendar year following the calendar year in which you retire from the employer sponsoring the plan.
Five percent owners may not defer the distributions beyond April 1 of the calendar year following the calendar year in which they retire. If you are a five percent or greater owner, be certain to observe this rule when the time comes or you may face substantial penalties.
How long do I have to distribute the balance of my account?
The number of years you use in determining the RMD depends on your age when you start. The age of the beneficiary is of no account assuming 1) your spouse is not the sole beneficiary and 2) the distributions begin before you die. In this case, you use the standard tables provided by the IRS. If your spouse is the sole beneficiary and is more than ten years younger, then you must us the joint life expectancy tables supplied by the IRS.
If you die before the required start date, then your heirs/beneficiaries have a choice of two methods to compute the RMD - the five-year rule or the life expectancy rule. The method used depends on whether you have a designated beneficiary and whether your designated beneficiary is your spouse.
Under the five-year rule, the entire balance of your account must be distributed by the fifth anniversary of your death, regardless of who receives the distribution. This method is required when there is no designated beneficiary. Be aware that your estate is not eligible to be treated as a designated beneficiary. Also, a trust is not considered a designated beneficiary, but if the trust is properly designed, the beneficiaries of the trust may qualify.
The life expectancy rule is what it sounds like. The distributions will be calculated using the life expectancy of the beneficiaries.
If the sole beneficiary is your surviving spouse, then your spouse basically steps into the your shoes. This means your spouse will either have to start the RMD by the end of the calendar year immediately following your death or the end of the calendar year in which you would have reached age 70 1/2. If your spouse dies after you, but before distributions are to begin, the life expectancy and five year rules are used based on your spouses' age.
If your spouse is not the designated beneficiary, then distributions must begin by the end of the calendar year following your death. This also applies if your spouse and another person are the designated beneficiaries. When the life expectancy rule is used and there is more than one designated beneficiary, the age of the oldest beneficiary is used in computing the RMD for all beneficiaries.
One other point to consider is if your surviving spouse elects to treat the IRA as his or her own. In this case, the timing of distributions will depend on the spouse's age, but the spouse must be the sole beneficiary and must have unlimited withdrawal rights. This requirement can't be satisfied if the beneficiary of the IRA is a trust, even if your spouse is the only beneficiary.
Do I have to take money out of each IRA?
If you have more than one IRA, you must determine the RMD separately for each IRA. However, you can draw the money out of only one account if you desire. This can be useful when you have one account earning a greater return than another. If you have several IRAs you hold as a beneficiary of a decedent, you would compute the RMD separately for each IRA, but you can withdraw the RMD out of any one those IRAs. The general rule, however, is you must treat IRAs from different decedents as separate accounts and, therefore, withdraw based on where you inherited the money.
For example, assume Jeff is the beneficiary of six IRAs. He received IRA 1 and IRA 2 from Bob, IRA 3 and IRA 4 from Amy and IRA 5 and IRA 6 from Stephen. Assume the RMDs are as follows: IRA 1 - $100; IRA 2 - $50; IRA 3 - $65; IRA 4 - $75; IRA 5 - $95; and IRA 6 - $105. Jeff can elect to take the RMDs from each account, or he can take $150 from either IRA 1 or 2, $140 from either IRA 3 or 4 and $200 from either IRA 5 or 6.
Distributions from 403(b) contracts or Roth IRAs cannot be used to satisfy the RMD requirements.
Conclusion
The IRS has taken great pains to make the RMD rules simpler. The new tables are easier to understand and the distributions are generally lower under the new regulations. However, considerable care is still needed to properly apply the rules. The increased assets remaining in IRA accounts can, in some circumstances, be a detriment rather than a boon and simple reliance on regulations without a review of the underlying plan documents could cause some bad surprises.
Don't let unwelcome surprises harm you or your loved ones. Give us a call today and let us review your situation and minimize the chance you or your family could be caught by surprise.
Have a great August!
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