There are still unknowns in the new Sec. 401(a)(9) regs.
© Barry C. Picker, CPA/PFS, CFP
Email: Barry@BPickerCPA.com
On January 11, 2001, the Internal Revenue Service issued new proposed regulations covering distributions from employer plans and IRAs. The intention of these new regulations was to simplify the computation of mandatory distributions for individuals reaching age 70˝ (or, if eligible, their later retirement date). No longer will people have to choose whether to recalculate their life expectancies or not. The identity of the beneficiary is of no consequence for lifetime distributions, except if one’s sole beneficiary is their spouse who is more than ten years younger.
The computation of distributions after the death of the account holder is also suppose to be simpler. (CAVEAT: While the computations may be simpler, the planning for retirement plan distributions is still quite complex. Practitioners and taxpayers should not think that this an area that can now be ignored). As long as there is a designated beneficiary, after-death distributions are based upon the designated beneficiary’s life expectancy. If there is no designated beneficiary, the payout schedule is determined by whether death occurred before or after the required beginning date. If before, the distributions have to made on no particular schedule, as long as the entire account is emptied by the end of the year of the fifth anniversary of the account holder’s death. If death occurred after the required beginning date, minimum distributions are taken each year based upon the remaining life expectancy of the deceased.
While most computations are now simpler, there are still some unanswered questions concerning how the new regulations will deal with certain circumstances. These unknowns could conceivably destroy carefully crafted financial plans, or cause an individual to take an improper distribution, possibly subjecting themselves to the 50% penalty for failure to take a required distribution.
One of these problems is a result of the new regulations’ date for determining the identity of the designated beneficiary. Under the old regulations, the designated beneficiary was determined as of the earlier of the required beginning date, or the date of death. The new regulations say that the designated beneficiary is determined as of the December 31st of the year after the year of the account holder’s death. The purpose was to allow post-mortem planning by allowing a beneficiary to disclaim in favor of a contingent beneficiary, or to allow the payoff of a beneficiary who did not qualify to be a designated beneficiary. If a non-designated beneficiary is paid off, remaining beneficiaries could them become designated beneficiaries.
The problem that is not addressed in the proposed regulations is the situation where a beneficiary survives the deceased account holder, but dies prior to the date for determining the designated beneficiary. In this case, the contingent beneficiary does not succeed to the account, since the original did not predecease the account holder. In most cases, the estate of the deceased beneficiary will inherit the right to the retirement account. Since an estate cannot be a designated beneficiary, the retirement plan would have to be paid out based upon their not being a designated beneficiary, thus destroying the planned long tax-advantaged stretch-out of the IRA.
The second area of difficulty involves an account holder whose sole beneficiary is their spouse, and the spouse is more than ten years younger. In this case, the account holder can utilize the actual joint life expectancy of the husband and wife, rather than the uniform distribution table that all other account holders will use. The actual joint life expectancy table will yield a smaller minimum required distribution than the uniform table will. The new regulations state that in order for the account holder to use the joint table, the spouse must be the beneficiary for the entire year. The problem arises if the beneficiary-spouse should die during the year. The spouse’s death means that the minimum required distribution for the year is immediately automatically increased. If the account holder is unable to withdraw the increased minimum required distribution from the account prior to the end of the year, either because the death occurred so late in the year that it is impossible, or just that the account holder was unaware of the need to take more, the 50% penalty could be imposed.
Hopefully, the final regulations will clarify the rules so that untimely deaths of beneficiaries will not cause retirement plan problems.
The third issue that needs to be resolved in the final regulations is the applicability of these new regulations to beneficiaries taking distributions from account holders who died prior to year 2000. Since the beneficiary of an account holder who died in 2000 has to take the first required distribution in 2001, the new rules are applicable.
For decedents who died prior to year 2000, the issue is two fold. One issue is whether the life expectancy of the designated beneficiary is calculated under the new rules or the old rules. If the account holder died before the required beginning date, the computation is the same under both old and new rules. However if the account holder died after the required beginning date, the old rule computation would then depend upon whether the account holder chose to recalculate his life expectancy, or not. In either event, the life expectancy period would count down from the year the account holder attained age 70˝. Under the new rules the life expectancy period starts counting down in the year after the year of the account holder’s death.
The second issue for beneficiaries of decedents dying prior to year 2000 is the identity of the designated beneficiary. The old rules identified the designated beneficiary on the earlier of the required beginning date or the date of death. The new rule identifies the designated beneficiary on the last day of the year following the year of death. Thus it’s very possible that a beneficiary was changed by the decedent after his required beginning date. If so, the beneficiary has to be computing minimum required distributions based upon the life expectancy of the person who was the beneficiary on the required beginning date. Can such a beneficiary now change the computation to use his or her own life?
One other possible scenario for a beneficiary of an individual dying prior to year 2000 is the case where the decedent died prior to his required beginning date, and the beneficiary failed to take the first minimum required distribution in the year after the year of death. The old rule meant that the beneficiary failed to elect the lifetime payout option, and was therefore stuck with the default five year rule. Under the new rule for death prior to the required beginning date, the lifetime payout is the default, with the five year rule only applying if elected or if there is no designated beneficiary. Under this scenario, will the beneficiary be permitted to pay the 50% penalty for the missed minimum required distribution, and continue computing minimum required distributions on the lifetime payout schedule, or are they stuck with the five year rule, as under the old rule?
Hopefully, the final regulations will clear up these, as well as any other, open questions.