United States: IRS Issues Final Regulations on Required Minimum Distributions

Article by Larry R. Goldstein and Mark R. Raymond

Section 401(a)(9) of the Internal Revenue Code of 1986 (the "Code") mandates required minimum distributions ("RMDs") from qualified retirement plans. Other Code sections impose the same requirements on other tax-favored retirement vehicles, including individual retirement accounts ("IRAs") and Code Section 403(b) tax-deferred annuity plans.

In April of this year, the Internal Revenue Service issued final RMD regulations, thus ending a process which began with proposed regulations issued in 1987. This Legal Update will summarize various key aspects of the final regulations, by reference to "individual account" plans, such as Code Section 401(k) plans and IRAs. There are also RMD rules applicable to annuity-type arrangements, such as defined benefit pension plans.

Required Beginning Date
An owner of an IRA (other than a Roth IRA) must start to receive distributions no later than his or her "required beginning date" ("RBD"), which is April 1 of the calendar year following the year in which the owner attains age 70-1/2. The RBD of a qualified plan participant who is a 5%-or-more owner of the employer sponsoring the plan is determined the same way, even if the participant is still actively employed.

For qualified plan participants who are not 5%-or-more owners, the plan may provide for a postponement of RMDs until April 1 of the calendar year following retirement, in the case of a participant who has already attained age 70-1/2 and is still employed. Some qualified plans, however, may require all participants, regardless of whether they are 5% owners, to start RMDs by April 1 of the calendar year following the year of attainment of age 70-1/2, the same as IRA owners.

As explained below, there are detailed RMD rules if the IRA owner or plan participant dies before all of his or her benefits have been distributed. These rules vary depending upon whether death occurs before or after the RBD.

Roth IRAs are not subject to the RMD rules while their owners are living. After the death of a Roth IRA owner, the RMD requirements are the same as those which apply to a non-Roth IRA whose owner has died before his or her RBD.

Distributions During Lifetime of Plan Participant/IRA Owner
The final regulations greatly simplify the calculation of RMDs for IRA owners and plan participants. Most individuals who reach their RBDs will determine the amount they must withdraw each year from a uniform table, regardless of whether they have named a beneficiary or who that beneficiary might be. The table is as follows for ages 70 through 85:

As an example, assume that an IRA owner was born on August 1, 1931. He attained age 70 in 2001 and reached 70-1/2 in 2002, so his RBD is April 1, 2003. His first RMD is for the year 2002, and he can either receive it any time in 2002 or by April 1, 2003. The amount of this first RMD is his IRA balance at December 31, 2001 divided by 26.5 (based on his attained age of 71 in 2002). His RMD for 2003 is the IRA balance at December 31, 2002 divided by 25.6. If he has postponed his RMD for 2002 until no later than April 1 of 2003, he will have two required distributions in 2003.

An IRA owner can always withdraw more than the required RMD each year. However, any excess is not counted against the RMDs in future years.

As the uniform table is based on updated mortality data, it will generally produce higher divisors, and therefore lower RMDs, than the tables provided in the 1987 proposed regulations or the tables in revised proposed regulations issued in 2001.

There is an exception to the use of the above table for one whose spouse is named as his or her sole beneficiary for the entire year and who is more than ten years younger. In such a case, the RMD for that year is determined based on a joint life expectancy table in the final regulations.

Death of Plan Participant/IRA Owner Before RBD
If a plan participant or IRA owner dies prior to his RBD, even if he or she has been taking withdrawals, RMDs are determined based on whether there is a "designated beneficiary." If there is such a beneficiary, distribution is over a period equal to such beneficiary's life expectancy, as determined by a table in the regulations, in the year after death. For subsequent years, the divisor determined under this table is reduced by one. If there is no designated beneficiary, the entire plan benefit/IRA balance must be distributed by December 31 of the fifth anniversary year of the death of the plan participant/IRA owner.

A "designated beneficiary" must be an individual. If a trust is named as beneficiary, the individual beneficiaries of the trust will be treated as designated beneficiaries if certain requirements are met as to the terms of the trust and certain documentation as to the trust is provided to the plan administrator or IRA custodian or trustee. This same rule does not apply to an estate, however; therefore, if an estate is named as beneficiary, the five-year rule will apply.

The determination of the designated beneficiary is to be made as of September 30 of the year following the year of the death of the plan participant/IRA owner. This will allow for certain post-mortem estate planning, such as through the use of qualified disclaimers.

If more than one individual is named as beneficiary, the life expectancy of the oldest individual is used. However, if permitted under the plan or IRA, the decedent's benefits could be divided into separate shares, one for each beneficiary, in which event the life expectancy of each beneficiary would apply to his or her share. Under the final regulations, such separate shares must be established by December 31 of the year following the year of the decedent's death.

Additional rules apply where the decedent's surviving spouse is a designated beneficiary. Such spouse may roll over his or her benefit tax-free to an IRA and take RMDs from that IRA as its owner. Alternatively, the spouse may be able to defer RMDs from the decedent's account in the plan or IRA until the year the decedent would have attained age 70-1/2.

Death of Plan Participant/IRA Owner After RBD
If the plan participant/IRA owner dies after his or her RBD, the RMD for the year of death must be paid during that year, if it had not been paid to the decedent prior to his or her death.

RMDs for the years following the year of death also depend on whether there is a designated beneficiary. If there is a designated beneficiary, basically the same rules apply as when a plan participant/IRA owner dies prior to his or her RBD (except that in the rare case when the designated beneficiary's life expectancy is less than the decedent's, the latter can be used). If there is no designated beneficiary, the divisor for post-mortem distributions is based on the decedent's life expectancy in the year of death, reduced by one for each subsequent year.

Special rules apply to benefits payable to surviving spouses, similar to the rules described above in the event the decedent dies before his or her RBD.

Effective Date
The final regulations are effective for determining RMDs in calendar years beginning on or after January 1, 2003. IRA owners and beneficiaries should be able to determine RMDs in 2002 using either the final regulations, the 1987 proposed regulations or the 1991 proposed regulations, but they should consult with their IRA custodians or trustees. A plan participant who must take an RMD in 2002 should consult with the administrator of the plan to determine whether the plan offers this flexibility.

Qualified plans must be amended to incorporate the requirements of the final regulations by the last day of the first plan year beginning on or after January 1, 2003. Model amendments were issued this past May in Revenue Procedure 2002-29.

Observations
In determining how to amend their plans to satisfy the final regulations, sponsors of qualified defined contribution plans may want to opt for minimizing administrative complexity by adopting provisions which do not permit RMDs over as long a period as the regulations allow. IRAs, by contrast, are structured to handle long-term payouts and indeed most IRA custodians and trustees want to see IRA assets remain under their auspices for as long as possible.

IRA owners, therefore, should generally have greater opportunities than qualified plan participants for tax and estate planning under the final regulations. Consequently, a plan participant who is entitled to a distribution (such as on account of termination of employment) and who is concerned about RMD planning should consider making a tax-free rollover to an IRA.

As shown above, much of the planning for RMDs under the final regulations is based on who has been named as beneficiary. Past strategies for minimizing RMDs under the proposed regulations may no longer be necessary or appropriate. Distribution elections and existing beneficiary designations should therefore be re-evaluated in light of the final regulations.

Ross & Hardies periodically publishes Legal Updates on employee benefits developments that may be of interest to our clients and friends. If you would be interested in discussing the issues herein, please call Larry R. Goldstein (312-750-8633), Mark R. Raymond (312-750-8612) or your regular contact at Ross & Hardies.