When the Internal Revenue Service issued final regulations on April 16 governing minimum required distributions from qualified plans and individual retirement accounts, Steven Lockwood immediately got on the horn to a 78-year-old client who withdraws the minimum from a $5 million IRA.
The regs include newly updated life-expectancy tables (Americans are living about one year longer these days) that reduce the amount retirement-account owners can withdraw, says Lockwood, president of Lockwood Pension Services Inc., a Manhattan pension-consulting firm. "I told the client, 'If you swing over to the new Uniform Lifetime Table now, we can adjust your remaining 2002 monthly withdrawals to reflect the fact that you took out too much earlier in the year.' He doesn't need the IRA to live on," Lockwood says of the client, "and he doesn't want to withdraw any more than required so that he can leave his spouse, who is 55, a larger rollover. The fact that he could take out less under the new regulations made him very happy."
To be sure, reducing minimum required distributions (MRDs) may be the most significant planning opportunity available. The latest rules generally follow in the footsteps of proposed regulations issued in early 2001. Nevertheless, advisors need to be aware of how new details impact clients with retirement-plan assets.
Impact On 2002
The new rules take effect in 2003. However, 2002 distributions (based on December 31, 2001, account balances) may be calculated using the new regs, the 2001 rules or the original MRD regulations promulgated in 1987. In most cases, clients with the objective of minimizing distributions should choose the new regs for 2002, says George H. Coughlin II, a certified financial planner in Walnut Creek, Calif., and author of the content at his Web site, www.iraplanning.com. "You get more stretch-out" with the new tables, Coughlin says.
One exception is when an account owner chose payout under the 1987 rules over his life jointly with a nonspouse beneficiary and the account owner has since died. In some of these cases, says Coughlin, the beneficiary will get the lowest payout in 2002 by continuing to use the appropriate joint-life factor coupled with the 1987 regs, since joint lives will typically be longer (producing a smaller distribution) than the single-life expectancy that's required under either the 2001 or new rules (discussed below in more detail).
The new tables may be used by clients currently taking a series of substantially equal periodic payments under Section 72(t) of the Internal Revenue Code (which permits penalty free pre-591/2 withdrawals) if they have been using the minimum distribution method, says retirement planning expert Natalie Choate, an attorney with Bingham Dana LLP in Boston. (See Choate's Web site, www.ataxplan.com, for her summary of the new rules.) Switching to a new life-expectancy table won't be considered a penalty triggering modification to the series, Choate says, although the regulations are mum about when the switch may be made. The regs also are silent about whether the new IRS tables may be used by taxpayers who currently are computing 72(t) payments via the amortization or annuity-factor methods.
Some who took their entire 2002 required minimum before the regs were issued may be able to roll back amounts withdrawn in excess of the minimum that would have been calculated with the new tables, says Michael J. Jones, a partner in the Monterey, Calif., accounting firm Thompson Jones LLP. The normal 60-day period for rollovers applies, Jones says. But if that's elapsed, too bad. "And you can rollover only if you're the participant or the surviving spouse. Nonspouse beneficiaries can't do rollovers from an inherited account," Jones says.
Clients keen to use the new tables for 2002 should inform the administrator as soon as possible, says Lockwood, who sent a missive to his client's IRA custodian stating, "Under the final regulations, we elect the application of the final regulations to 2002." Lockwood also provided a calculation showing the custodian the monthly amount to be paid out for the rest of 2002, given that the client's first four monthly payments had assumed an annual distribution of $260,417 while the new uniform lifetime table requires only $246,305.
Rule For Beneficiaries
Beneficiaries electing the final regulations for 2002 must comply with a new requirement (which they'll have to follow in 2003 anyway) mandating that post-death MRDs be determined in accordance with the final regulations even if the account owner died years ago. Stated another way, the latest rules must be applied retroactively. For example, says Coughlin, with respect to account owners who died after the required beginning date, the final regulations now call for a nonspouse beneficiary's current distributions to be based on the longer of: a) his single-life expectancy in the year after death, reduced by 1.0 for each year thereafter, or b) the single-life expectancy of the deceased account owner in the year of death, reduced by 1.0 for each year subsequent to death. Translation: a nonspouse who heretofore had been using joint lives gets bumped to a single life, increasing the withdrawal in the typical case.
Furthermore, a beneficiary must ascertain the account's designated beneficiary(s) on September 30 of the year following the owner's death-a change from December 31 of the year after death-then reconstruct the life expectancy to be used currently. "You have to get the beneficiary-designation form that the IRA owner had at death, see who was the beneficiary, and see if there were disclaimers or distributions that eliminated beneficiaries" by the September 30, says Jeremiah W. Doyle IV, a vice president at Mellon Bank's Private Wealth Management Group in Boston. Who's got the paperwork you need? Who knows, what with the mergers financial services has seen.
Unfortunately, verifying the designated beneficiary is just the first step. Assuming that the designated beneficiary is, in fact, the individual who is currently getting distributions from the account, his life expectancy must be reconstructed based on the IRS' new tables. "Determine the age of the beneficiary in the year after death of the account owner, and look up that age in the new table to come up with a new factor" as a starting point, says Coughlin. Suppose the account owner died in 1998 and the beneficiary, an older brother, turned 40 in 1999 (the first year the beneficiary is required to take a distribution). The IRS' new single-life table shows a life-expectancy of 43.6 years for a 40-year-old. Following the reduce-by-1.0 algorithm, the brother's life-expectancy for 2002 is 40.6, viz.: 1999's 43.6, minus 1.0 for each year after 1999. Keep tabs on whether your clients' administrators are properly reconstructing the correct life expectancy, experts advise.
Window Of Opportunity
When an account owner dies before the required beginning date and there is a designated beneficiary, the default distribution rule (which applies when there is no election by the beneficiary or plan provision to the contrary) is now life expectancy. Gone is the rule requiring the account to be emptied by December 31 of the fifth year after the year of the account owner's death, says Lockwood. For beneficiaries stuck with the five-year rule, a fabulous remedial provision in the new regs allows a switch to life expectancy by December 31, 2003. The only hitch is that all amounts that would have been distributed had the life-expectancy method been used from the beginning must be distributed-a "catch-up distribution," if you will-by December 31, 2003, or for deaths in 1997, December 31, 2002. According to Choate, this transition rule offers a valuable opportunity for beneficiaries who previously missed out on life-expectancy payout.
Changes For 2003
Starting in 2003, lifetime distributions must be calculated using the new Uniform Lifetime Table unless the sole beneficiary is an account owner's spouse who is more than 10 years younger, in which case the spouses' actual joint lives may be used, Coughlin says. Under the 2001 proposed regs, the spouse had to be the sole beneficiary on the account for the entire year in order to use the joint-life table. "If the spouse died or you divorced, tough luck," Coughlin says. The final rules, however, look at marital status as of January 1-in other words, if there is a divorce during the year, the joint-life table can nevertheless be used for that year. Ditto if the young spouse dies during the year and the account owner names a new beneficiary. "This is a nice clean-up" of the prior rules, Coughlin says.
Another fix concerns the life to use when the beneficiary dies after the account owner but before the September 30 designation date. The final regs clarify that the payout is governed by the deceased beneficiary's life expectancy, not that of a successor beneficiary, Doyle says.
For trusts that are retirement-account beneficiaries, there is a new deadline for getting documents to the custodian when the account owner dies. Formerly December 31 of the year after death, the deadline has been advanced to October 31 of the year following death, improving practicality. Doyle says, "As a time line, on September 30 (of the year following the account owner's death), you see that the designated beneficiary is the trust. The trust then knows it has until October 31 to send a copy of the trust documents or a certification of the beneficiaries [naming the beneficiaries and their rights in the account] to the trustee or custodian. And then the beneficiaries have until December 31 to take the distribution."
Contrary to the conclusiveness that final regulations suggest, things are far from settled in this area of retirement planning, says Jones, the CPA in Monterey. Fifteen years in the making, the April 16 promulgation leaves some things unclear while raising new questions. Jones previews the next chapter: "Regulations end up in court. It happens every year-and in abundance."