Estate Planning for Retirement Benefits

The Internal Revenue Service recently issued proposed regulations pertaining to required minimum distributions from qualified retirement plans, individual retirement accounts (IRAs), certain nonqualified retirement plans, section 403(b) annuities, custodial accounts and retirement income accounts.

Given the breadth of the new proposed regulations and the potential impact to many of our clients, we have prepared this memorandum to briefly describe the new proposed regulations and whether it may be advisable to have your retirement account distributions and beneficiary designations reviewed.

Background

In 1987, the IRS issued proposed regulations addressing the distribution requirements for certain retirement plans and accounts. The proposed regulations were intended to address (i) distributions prior to attaining the age of mandatory distribution (generally, age 70½ years); (ii) required minimum distributions upon attaining the mandatory distribution age; and (iii) distributions in the event of the retiree’s death. These regulations were amended in 1997 to address distributions to trusts.

The 1987 proposed regulations were believed to be overly complex. Further, under the 1987 proposed regulations, a taxpayer was required to make certain irrevocable decisions upon reaching 70½ years old. These elections could often times dramatically impact the taxpayer’s required minimum distribution and the taxation of the retirement accounts after the taxpayer’s death. Although proposed 14 years ago, these regulations were never finalized, leaving taxpayers in state of uncertainty.

New Proposed Regulations

The new proposed regulations (herein referred to as the “Proposed Regulations”) are clearly a simplification of the previously complex set of distribution rules. Recognizing that financial and family circumstances could change, the Proposed Regulations generally eliminate the need to fix the amount of the distribution during the taxpayer’s lifetime based on the beneficiary designated on the required beginning date and eliminates the need to elect recalculation or no recalculation of life expectancies at the required beginning date.

For lifetime required distributions, the Proposed Regulations adopt a calculation method using the so-called minimum distribution incidental benefit (MDIB) divisor table, except where the beneficiary is the taxpayer’s spouse and the spouse is more than 10 years younger than the taxpayer. The MDIB table is based on the joint life expectancies of an individual and a survivor 10 years younger at each age beginning at age 70. Using the MDIB table, most taxpayers will be able to determine their required minimum distribution for each year based on nothing more than their current age and their account balance as of the end of the prior year (which IRA trustees report annually to IRA owners). For the majority of taxpayers, required minimum distributions will be reduced as a result of this change.

Under the 1987 proposed regulations, the taxpayer’s choice of a “designated beneficiary” was determined, irrevocably, as of the required beginning date (i.e. age 70½ years). The Proposed Regulations provide that, generally, the designated beneficiary is determined as of the end of the year following the year of the taxpayer’s death. Thus, any beneficiary “eliminated” by distribution or otherwise during the interval between the participant’s death and the end of thefollowing year is disregarded. This would mean, among other things, that if some portion of the account is designated to a charity, and the distribution is made prior to the end of the year following the participant’s death, the presence of a non-individual beneficiary will not prevent a “stretch-out” of the retirement accounts after death.

The approach for determining the designated beneficiary following the death of an employee after the taxpayer’s required beginning date is simpler in several respects than the approach in the 1987 proposed regulations. Under this approach, a taxpayer with a designated beneficiary is now provided with the same rules for distributions after the taxpayer’s death, regardless of whether death occurs before or after the taxpayer’s required beginning date (i.e. age 70½) . Finally, in the case of a taxpayer who had elected or defaulted into recalculation of life expectancy and who dies without a designated beneficiary, the requirement that the taxpayer’s entire remaining account balance be distributed in the year after an taxpayer’s death has been eliminated and replaced with a distribution period equal to the taxpayer’s remaining life expectancy recalculated immediately before death.

The Proposed Regulations also simplify the requirements for trusts named as retirement account beneficiaries. Generally, as under the previously proposed regulations, the trust can be a named beneficiary but the trust is not considered the “designated beneficiary.” Only an individual may be a designated beneficiary for purposes of determining the distribution period.

Under the Proposed Regulations, however, if the following requirements are satisfied, the beneficiaries of the trust will be treated as having been designated as beneficiaries under the plan for purposes of determining the distribution period:

The trust is a valid trust under state law;

The trust is irrevocable or will, by its terms, become irrevocable upon the death of the taxpayer;

The beneficiaries are identifiable from the trust instrument;

Either (1) The taxpayer provides to the plan administrator a copy of the trust instrument and future amendment(s); or (2) the taxpayer provides to the plan administrator a list of all of the beneficiaries of the trust and agrees to provide a copy of the trust instrument to the plan administrator upon demand.

The Proposed Regulations preserve the rule that permits a surviving spouse to “roll-over” a retirement account on the death of the taxpayer, thus electing to treat the retirement account inherited by the surviving spouse from that owner as the spouse’s own retirement account. The Proposed Regulations are somewhat less generous with respect to the use of trusts and spousal roll-overs, however.

Effective Date

The Proposed Regulations are applicable for determining required minimum distributions beginning in 2002. For determining required minimum distributions for 2001, taxpayers may rely on either the Proposed Regulations or on the 1987 proposed regulations.

Conclusion

This memorandum is not intended to be a comprehensive analysis of this complex area of the tax law nor is it intended to replace individual attention and counsel that is often required. If you would like additional information regarding any topic addressed or any other related topics, or have suggestions for issues to be discussed in the future, please call or e-mail us.