• Retire with Ease: New IRA and Qualified Retirement Plan Regulations
  • October 23, 2003 | Author: Amy J. Roberts
  • Law Firm: Patterson Belknap Webb & Tyler LLP - New York Office
  • In the hubbub over the new estate tax laws, we should not overlook the sweeping changes made by the Internal Revenue Service ("IRS") with respect to qualified retirement plans and IRAs. In January of 2001, the IRS issued new proposed regulations that radically alter the method for determining required minimum distributions of retirement plans. These new regulations not only simplify the old regulations but do so in a way that is advantageous to the taxpayer. Lifetime required minimum distributions from IRAs and qualified retirement plans are determined by dividing the account balance (revalued annually) by a life expectancy factor. A plan participant (the individual who owns the IRA or other retirement plan account) is required to withdraw an annual "minimum distribution" beginning the April of the calendar year after he or she attains age 70 1/2, and to pay income tax at ordinary income tax rates on the amount withdrawn. If a participant can afford to do so, he or she should withdraw the smallest amount possible to achieve maximum tax deferral. This will enable the principal to appreciate at a much greater rate providing more money for later years and increasing amounts ultimately passing to the beneficiary.

    Under the old regulations, the required minimum distribution was calculated in a complex manner based on the participant's life expectancy and that of his or her designated beneficiary. If a participant designated an older spouse to receive the assets upon the participant's death, their life expectancies were shorter than if a younger beneficiary had been named (though a younger beneficiary was deemed to be no more than 10 years younger than the participant). This shorter life expectancy required larger annual withdrawals which, in turn, accelerated the payment of income taxes. Thus, the old rules provided incentives for naming young beneficiaries; the relevant criteria were not simply to whom the participant wished to leave the retirement assets. There were also disincentives to naming a charity as the designated beneficiary because a charity was deemed to have no life expectancy. The effect of this was to calculate the minimum distribution solely on the participant's life expectancy, thus requiring a larger taxable withdrawal than would be the case with an individual beneficiary.

    Under the new regulations, the age and identity of the designated beneficiary have no impact on the amount of the participant's required minimum distribution. Instead, life expectancy and thus the amount of the annual distribution are calculated under one uniform table based on the joint life expectancies of an individual and an assumed survivor 10 years younger at each age, beginning at age 70 1/2 . Thus, all participants are deemed to have a life expectancy calculated as if it were a joint life expectancy of the participant and another individual 10 years younger, regardless of the identity or age of the designated beneficiary or even if there is no beneficiary. (The only exception is if the participant's sole designated beneficiary is a spouse more than 10 years younger, in which case the actual joint life expectancy is used.) The effect of this will greatly extend the tax deferral for most participants. In addition, the life expectancy factor is recalculated every year eliminating the need for participants and their spouses to choose between a fixed term or annual recalculation of life-span.

    Moreover, an individual will no longer be penalized for designating a charity as the beneficiary of a retirement plan. For those with charitable intent, this presents an excellent estate planning vehicle. If a charity is named as beneficiary, both an estate and an income tax deduction are available and, under the new distribution rules, the identity of the beneficiary in no way affects the participant's minimum distribution. Thus, a participant should consider satisfying his or her charitable bequests from these assets which would otherwise be so heavily taxed and leave other assets not subject to income tax upon death to family and friends.

    The new regulations also have simplified the rules regarding distributions after the death of the participant and permit some post-mortem planning. The designated beneficiary is not determined until the last day of the calendar year following the calendar year of the employee's death. This does not mean that you can "change" the designated beneficiary up to one year after the participant's death as has been widely and erroneously reported in the press.

    Rather, this allows an older primary beneficiary to disclaim his or her interest so that a younger secondary beneficiary (a child for example) can obtain the longer tax deferral. As after death distributions generally must be withdrawn over the beneficiary's fixed term life expectancy, distributions over a younger beneficiary's life expectancy will allow the IRA to appreciate tax free for a longer period of time. Different rules apply for a spouse, however, who may roll over the IRA into his or her own name and be treated as if he or she were the participant. If the spouse does not roll over the benefits, the rules remain complicated.

    The new rules also allow beneficiaries to establish separate accounts. This is vital if there is both a charitable and non-charitable beneficiary and may be useful (the law remains unclear) where there are multiple individual beneficiaries of various ages. In brief, it appears that accounts may be divided so that each beneficiary may obtain his or her own distribution schedule based on his or her life expectancy.

    In sum, the good news is that these new rules have been greatly simplified in a manner that is favorable to the taxpayer. The bad news is that they remain sufficiently complex and technical that a participant during his or her life and a beneficiary promptly upon the death of a participant should obtain proper advice in exploring their options to achieve their estate planning goals in a tax efficient manner.

    The new proposed regulations have became final and mandatory for calendar years beginning on or after January 1, 2002.