Treasury Proposes New Simplified Rules for Retirement Plan Minimum Distributions

On Jan. 19, 2001, Treasury issued proposed regulations substantially simplifying and reducing the minimum required distributions (MRDs) from most retirement plans. The new proposed regulations replace proposed regulations issued in 1987, and they spell out the MRDs for tax-qualified retirement plans.

Current law prescribes substantial penalties for taxpayers who are age 70¹/2 and do not take the MRD from their retirement plans. Until now, MRDs could be determined under several different methods. The employee had to select a method before the required beginning date (RBD); once selected, the employee was locked in and could not adopt a different method in a later year, even if his situation changed. While not simple, the new proposed regulations are simpler than the 1987 proposed regulations and, in many cases, require a smaller MRD.

Lifetime Distributions

The proposed regulations require that, during life, almost everyone must use the same method for calculating their MRDs. The one exception is for an employee with a beneficiary who is a spouse more than 10 years younger than the employee. In that situation, the MRD is based on a longer payout period, resulting in a smaller MRD.

MRDs must begin by the RBD. For all employees (except five-percent owners and IRA owners), the RBD is April 1 of the year following the later of the year the employee either retires or reaches age 70¹/2. For five-percent owners and IRA owners, the RBD is April 1 of the year after the year the employee turns 70¹/2, even if he has not retired.

Exhibit 1, the Uniform Distribution Period Table, presents the data used to calculate MRDs for any year requiring distribution. The table is the same as the table identified as the Minimum Distribution Incidental Benefit (MDIB) table prescribed in the 1987 proposed regulations. Under the new proposal, a taxpayer's minimum distribution for any calendar year is the quotient obtained by dividing the employee's account balance by the distribution period obtained from the Uniform Distribution Period Table.

Minimum Required Distribution Calculation

The employee's account balance is the balance in his retirement account as of the last day of the preceding calendar year. The employee's distribution period is found in the Uniform Distribution Period Table, and it represents the joint life expectancy of the employee and a beneficiary. In the table, the distribution period is the period that corresponds to the taxpayer's age on his birthday in the distribution year.

Using the table is much easier than using the old rules. In nearly all situations, everyone uses the same simple rule. Since the MRD is not dependent on the beneficiary's age, beneficiaries can be changed without changing the MRD. The employee does not even have to name beneficiaries until the end of the year following the year of his death.

Using the Uniform Distribution Period Table is not only simpler, but, for many employees, is also less expensive than the old rules. The table assumes a beneficiary with a life expectancy of 10 years less than the taxpayer (even if there is no beneficiary). Thus, every employee gets the same maximum benefit, regardless of the beneficiary's actual age. The one exception occurs when the beneficiary is the employee's spouse who is more than 10 years younger than the employee. In that situation, the Uniform Distribution Period Table is not used. Instead, the applicable distribution period is the actual joint life expectancy of the employee and spouse based on their ages attained in the distribution year.

The MRD computation described applies to all years beginning with the year that includes the RBD and ends with the year of the employee's death. Exhibit 2 summarizes an employee's lifetime MRD requirements.

Distributions after Death

Once an employee dies, the remaining balances in his retirement accounts must be paid out to the account beneficiaries. Exhibit 3 presents a summary of the relevant MRD requirements. In most instances, such distributions begin in the year after the employee's year of death. The distribution options and length of the distribution period depend on who the beneficiaries are and whether or not the employee's RBD fell before the date of death.

If the MRD is based on a life expectancy, the computation of life expectancy is either made annually or is fixed. If the distribution period is computed on an annual basis, the determination of the beneficiary's life expectancy is yearly, based on his age attained during the year. If the calculation is on a fixed basis, it is determined only once; each year after the first distribution, the distribution period reduces by one.

Death on or after the RBD. If the employee dies on or after the RBD, any remaining balance in his retirement account would be paid out over the designated beneficiary's life expectancy. If the beneficiary is not a spouse, the life expectancy would be fixed and based on the beneficiary's age on the beneficiary's birthday in the year following the employee's year of death. If the account has multiple beneficiaries, the distribution period would be based on the oldest beneficiary's life expectancy. If the employee has no designated beneficiary (or if any beneficiary is not an individual), the distribution period would be a fixed period determined by the employee's life expectancy as of his age on his birthday in the year of death, reduced by one.

Spouses who are sole beneficiaries of retirement accounts have the option of rolling over the account balances to their own IRAs. Similarly, a spouse who is the sole beneficiary of an inherited IRA may elect to treat (or redesignate) it as his own IRA. In those situations, the spouse is placed in the position of the employee, with all the options available to an IRA owner. If the balances are not rolled over or redesignated, the spouse would be subject to the MRD rules as a beneficiary.

The MRD rules require that if the sole beneficiary is a surviving spouse, the distribution period would be computed annually. Once the spouse dies, the remaining balance must be paid to the spouse's beneficiary or beneficiaries over the spouse's life expectancy, based on his age in the year of death. Note: the same life expectancy is used twice—once by the spouse in his year of death, and again by the spouse's beneficiary in the year following the year of death. An important difference, however, between the spouse and the spouse's beneficiary is that recomputation of the distribution period for the spouse is on an annual basis, while the distribution period for the spouse's beneficiary is on a fixed basis.

Death before the RBD. Many MRD rules are the same, regardless of when the employee dies; however, some, like the five-year rule, are different. If the employee dies before his RBD, one method available for distributing a retirement account balance is the five-year rule. An employee may elect the five-year rule and, in some situations, it is required. If the five-year rule applies, the entire balance of the employee's account would be distributed by the end of the year that includes the fifth anniversary of the employee's death. This rule may apply regardless of which beneficiary receives the distribution. The rule also applies when there is no designated beneficiary or if any beneficiary is not an individual.

If the five-year rule does not apply, the balance of the account would be paid out over the designated beneficiary's life expectancy. If the beneficiary is not a spouse, the life expectancy would be fixed and based on the beneficiary's age on his birthday in the year following the employee's year of death. If there are multiple beneficiaries for the same account, the distribution period would be based on the oldest beneficiary's life expectancy.

If the account's sole beneficiary is a surviving spouse, the distribution period would be determined annually. Payments to the spouse must begin by the later of the end of the year immediately following the year of the employee's death or the end of the calendar year in which the employee would have reached age 70¹/2.

When the surviving spouse dies, the remaining account balance must be distributed to the spouse's beneficiary or beneficiaries. If the spouse, like the employee, also dies before his RBD, the account would be treated as though the spouse was the employee, with the spouse's date of death substituted for the employee's. If the spouse dies on or after his RBD, the remaining balance would be paid out over a fixed period, which is the spouse's life expectancy, based on the spouse's age in his year of death, reduced by one.

Conclusion

It appears that the Treasury has truly attempted to address many of the concerns taxpayers had with the 1987 MRD rules. The new proposed regulations are simpler, yet provide the taxpayer with more flexibility and, in many instances, a lower MRD. It is anticipated that the final regulations will apply starting in 2002. In 2001, taxpayers may compute the MRDs using either the old or the new rules.

From Wayne M. Schell, CPA, PhD, Christopher Newport University, Newport News, VA (Not affiliated with DFK International)