New Minimum Distribution Regulations Bad News for Some Beneficiaries

New Minimum Distribution Regulations Bad News for Some Beneficiaries

© 2002, Barry C. Picker, CPA/PFS, CFP
www.BPickerCPA.com
Email: Barry@BPickerCPA.com

The final minimum distribution regulations issued by the Internal Revenue Service on April 17, 2002 represent good news for most taxpayers. These regulations finalized proposed regulations issued in January, 2001. The proposed regulations simplified the computation of lifetime distributions and were supposed to simplify the computation of post-death distributions to beneficiaries. At the time of the issuance of the proposed regulations, it was thought that the new rules could only help taxpayers.

The final regulations clarified many unanswered questions from the proposed regulations. One of those questions was whether or not the new rules would apply to beneficiaries who were already taking distributions from inherited accounts. That question has now been answered in the affirmative. Starting in 2003, and optionally for 2002, beneficiaries of inherited accounts must use the new regulations to determine their annual minimum required distribution. For many beneficiaries, the new regulations will be beneficial, resulting in smaller annual minimum required distributions. However some beneficiaries may be forced to take larger minimum required distributions; in some potential cases, significantly more.

Regulation 1.401(a)(9)-1, A-2(c)(1) states that the distribution rules of the regulations apply to account balances held for the benefit of a beneficiary, starting in 2003, even if the account holder died prior to 2003. The regulation further holds that the designated beneficiary must be redetermined according to the rules of Regulation 1.401(a)(9)-4 (Determination of the designated beneficiary). The distribution period will then be accordingly reconstructed, taking into account the new life expectancy tables of Regulation 1.401(a)(9)-9.

The main issue, however, will be the redetermination of the designated beneficiary according to the new rules.

Under the old regulations, the designated beneficiary was determined as of the earlier of the required beginning date (April 1^st of the year after age 70½ or, in some cases, a later retirement) or the date of death. Under the new regulations, the designated beneficiary is determined as of September 30^th of the year after the year of death. Each beneficiary will now have to go back to review their account situation to see if the beneficiary had changed between the old determination date and the new September 30^th determination date. The change could either be positive adjustment (a longer payout period) or negative one (a shorter payout period). The new regulations do not limit their applicability to only positive adjustments. The problem is that it is too late to do anything about these unplanned changes.

Situations where the designated beneficiary would be different under the old rules and the new rules include, change of beneficiary after the required beginning date, a valid disclaimer by the original beneficiary, splitting of the accounts after the death of the account holder, or the death of the beneficiary after the required beginning date but before the account holder.

Changing the beneficiary after the required beginning date would not cause a negative change under the new rules. That’s because under the old rules, if the new beneficiary had a shorter life expectancy than the old beneficiary, you had to change to that beneficiary’s shorter life expectancy during lifetime. If the new beneficiary had a longer life expectancy, you were stuck with the old beneficiary’s shorter life expectancy. The new rules will now permit you to change to the new beneficiary’s longer life expectancy.

Splitting of the accounts after death would also not cause a negative change. For the oldest beneficiary whose life was the measuring life, there would be no change. The other beneficiaries could now get the advantage of their own longer life expectancy.

A valid disclaimer or the death of the original beneficiary are situations that could result in a negative adjustment, especially if the account is now deemed to not have a designated beneficiary. In that case, the payout period will revert to the life expectancy of the account holder.

The following is an example of how this can happen. Let’s say that H attains age 70½ in 1996, the year of his 70^th birthday. His beneficiary is age 40 in that year. No contingent beneficiary is named. The beneficiary dies in 1997, and H does not name a new beneficiary. H then dies in 1998. Under the old rules, the account would be paid out over the remaining years of the beneficiary’s actuarial life expectancy computed in 1996. Under the old table that was 42.5 years. Therefore the account will be paid out starting in 1999 (the year after H’s death) over 39.5 years (42.5-3). The divisor for calendar year 2002 would then be 36.5 years. For 2003, the designated beneficiary needs to be redetermined. Since there was no beneficiary at the date of death, there can be no beneficiary on the September 30^th determination date. The account now has to be distributed under the new rules, without a designated beneficiary. The new rules require you to look at the life expectancy of H, as of the year of his death, under the new table. H’s died at the age of 72. The new table’s life expectancy for a 72 year old is 15.5. Since 2003 is five years later, the divisor for 2003 is 10.5. In this case, the new rules will result in a distribution for 2003 that more than three times greater than what the distribution would be under the old rules.

A similar situation can arise in the case of a beneficiary who disclaimed, when there was no contingent beneficiary named on the account. Under some circumstances, the account could still have been being paid out over the disclaiming beneficiary’s life expectancy. Now, the payout period will revert to the account holder’s life expectancy.

Beneficiaries need to be aware of the ramification of the new regulations to make sure that they can stretch out their distributions for as long as the law allows, while not subjecting themselves to the 50% penalty for failure to take the proper minimum distribution.