April 17, 2002

Press Release from:

Ed Slott, CPA
Publisher, Ed Slott's IRA Advisor
Rockville Centre, NY
516-536-8282

April 17, 2002 -
IRS Issues Final Regulations on Retirement Plan Distributions

IRS has finalized the new distribution rules that were proposed in January 2001.

The IRA distribution rules just got even better than before! IRA owners, plan participants and their beneficiaries will all benefit from the changes.

You can download a complete copy of the Final Regulations as a PDF file or a Microsoft Word version from the home page of our website http://www.irahelp.com. These new rules are effective January 1, 2003, but can be used to calculate your 2002 required distributions. These rules apply to beneficiaries as well as IRA owners and plan participants.

In General
Overall, the IRS kept the general framework they created in the January 2001 Proposed Regulations based on the positive feedback they received from both the public and professionals. The changes in these Final Regulations are additional simplifications and corrections to the Proposed Regulations based on comments received over the last year. There are also a number of valuable provisions geared to beneficiaries that will let them correct prior mistakes and take advantage of the new rules.

Here is a rundown of the major provisions:

New Life Expectancy Tables
IRS has issued new life expectancy factors for the three life expectancy tables that IRA owners and beneficiaries use to compute required minimum distributions. The three tables are the Uniform Lifetime Table, the Single Life Table and the Joint life Table. These tables can also be downloaded from the homepage of our website at http://www.irahelp.com.

The tables have not been changed in 20 years, but the change in life expectancy is minor - only about an additional year. You would have thought that after all the advances in technology in the last 20 years, we would have earned at least more than one year of additional life expectancy.

The huge changes in the required distribution amounts that resulted from the January 2001 Proposed Regulations were due to a change in the method of using the life expectancy tables, but the tables themselves did not change. The Final Regulations changed the life expectancy tables but kept the method of using them that was established in the Proposed Regulations. Required distributions and the resulting income tax will still be slightly lower. Most people will pay less tax.

1. Uniform Lifetime Distribution Table
This will be used by most IRA owners and plan participants for figuring lifetime required distributions - generally after reaching age 70 ½. The only IRA owners who will not use this table will be those whose spouse is their sole beneficiary for the entire year and is more than 10 years younger (known as the "spousal exception"). Beneficiaries never use this table.

2. Joint Life Table
This table is used only for lifetime distributions and only when the spousal exception applies (when the spouse is the sole beneficiary and is more than 10 years younger than the IRA owner). Beneficiaries never use this table.

3. Single Life Table
This table is used by designated beneficiaries to compute required minimum distributions on inherited retirement accounts. This table will never be used to compute lifetime required distributions. Under the Final Regulations, this table can also be used by designated beneficiaries to correct or change the distributions schedule they were locked-into under the old rules.

New Reporting Requirements
IRS backed off the reporting requirements for financial institutions (the custodians and trustees holding IRA assets). Beginning in 2003, the custodians will have to report only to IRA owners and not the IRS. They can either give the IRA owners their required distribution amount or notify them that an amount is required and offer to figure that amount upon the IRA owner's request. The custodians do not have to report to beneficiaries at this time.

Beginning in 2004, the custodians will have to report to the IRS, accounts that are subject to required minimum distributions but NOT the amounts. This is a first step towards the broader goal of IRS reporting in order to check compliance. Eventually, IRS wants to be able to check that IRA owners and beneficiaries are withdrawing and paying tax on the required amounts.

New Date for Determining the Designated Beneficiary
In the Proposed Regulations from January 2001, the designated beneficiary was not determined until December 31st of the year following the year of the IRA owner's death. That was also the date that the first required distribution was due on the inherited account which in some cases would leave little time to calculate and withdraw the required amounts. IRS has fixed this problem by advancing the date that the designated beneficiary is determined to September 30th of the year following the year of the IRA owner's death. This will give beneficiaries and financial institutions an added three months to figure and withdraw required amounts. This does not mean that a designated beneficiary can be named after the death of the IRA owner. All designated beneficiaries, both primary and contingent, must be named by the IRA owner while he is still breathing. Then, after death of the IRA owner, the designated beneficiary can be changed, but only amongst the group of beneficiaries named by the IRA owner.

Death During the "GAP" Period
Since the designated beneficiary is not determined until September 30th of the year following the year of the IRA owner's death, a so-called "GAP" period is created. The gap period is from the date of death until September 30th of the year following the year of death. This gap period concept was created by the 2001 Proposed Regulations, but it raised the question of what would happen if the beneficiary died during the gap period. In other words, whose life expectancy would you use if the beneficiary died before he became the designated beneficiary. The Final Regulations answer this question by stating that the life of the deceased beneficiary will be used if that beneficiary dies in the gap period. Without this clarification, the beneficiary could end up being the estate of the deceased beneficiary which would mean there is no designated beneficiary and the longer life expectancy could not be used.

An Estate is NOT a Designated Beneficiary
This has always been the case, but the IRS made it clear in the Final Regulations that this is their position. This makes naming a beneficiary crucial. If the beneficiary is named through a will or through state law, that beneficiary will not be a designated beneficiary and will not be able to use his life expectancy to stretch distributions on an inherited IRA. The life expectancy of an estate is zero because an estate is not a designated beneficiary.

Beneficiaries Can Switch to the New Rules
The Final Regulations contain a provision that will allow designated beneficiaries who inherited years ago under the old rules to switch to the new rules. Under the old rules many beneficiaries ended up using the 5-year rule which meant that the entire inherited account had to be withdrawn by the end of 5th year following the year of death. But now if those beneficiaries were named by the IRA owner as of his or her death, they can switch to the life expectancy method based on the new tables. The one condition is that they have to take the distributions for the back years (if they have not done so already). This can save beneficiaries a fortune in taxes not to mention extending the life of their inherited IRAs. Also, those beneficiaries that were named by the IRA owner as of his or her death can switch to the new life expectancy tables even if they were not stuck with the 5-year rule, but were using another less favorable life expectancy method.

Multiple Beneficiaries
If you have named more than one beneficiary on a single IRA account, the general rule is that after death, required distributions have to be based on the age of the oldest beneficiary. IRS has confirmed their position that if the accounts are split into separate IRAs, then each beneficiary can use his own life expectancy to compute required distributions. The account must be split by the end of the year following the year of the IRA owner's death.

Spousal Exception
The spousal exception (from the Proposed Regulations) says that if your spouse is your sole beneficiary for the entire year and is more than 10 years younger than you, then you do not have to use the Uniform Lifetime Table for distributions and instead you can use the actual joint life expectancy from the joint life table.

Many people questioned what would happen if the spouse died or got divorced during the year?" The Final Regulations answered that question with a provision stating that the marital status will be determined as of January 1st of the distribution year. If the spouse dies or gets divorced during the year, you can still use the spousal exception for that year, but not for the following year.

Trust Documentation
In order for the beneficiaries of a trust that is named as your IRA beneficiary to qualify as designated beneficiaries, several requirements must be complied with. One of those requirements is to provide information on the trust beneficiaries to the plan administrator or IRA custodian or trustee. Under the new rules, that documentation must be provided by October 31st of the year following the year of the IRA owner's death. Old trusts that did not qualify because of the documentation requirement, will now be given until October 31, 2003 to provide the required documentation.

72(t) Payment Schedules
The new rules apply to existing 72(t) payment schedules. The only people affected would be those who were using the Minimum Distribution method to calculate their 72(t) payments. If you were using that method, you can now switch to the new tables to compute future 72(t) payments and the switch will NOT be considered a modification by IRS. However, this will not apply to that many 72(t) payment schedules since most people don't use the Minimum Distribution Method because it produces the lowest payouts.

Decline in Account Value - "The Enron Effect"
There is a 50% penalty for not taking a required distribution. But what if there is not enough money left in the IRA to take the full amount of your required distribution? Until now, the tax law never considered the possibility that your retirement account could decrease in value.

Well at least the IRS has a heart. In one line of all the 155 pages of Final Regulations, the IRS inserted what I call "The Enron Effect Clause." It says that if the value of your IRA or plan has dropped so much that when you compute your required distribution based on last year's ending balance, your required distribution amount exceeds your entire account balance, then you can simply empty the account. The IRS won't require you to withdraw more than you have. You will not be subject to the 50% penalty for not taking the full amount of your required distribution. Isn't that nice?

Roth IRAs
Required distributions from Roth IRAs (which only applies to Roth IRA beneficiaries) are now subject to the 50% penalty for not taking a required distribution. The 50% penalty provision in the tax law omitted Roth IRAs. The IRS has fixed that in the Final Regulations, but the law still must be corrected by Congress.

Older Beneficiaries Can Use the Longest Life
If you die after your Required Beginning Date (after you reach age 70 ½) and your designated beneficiary is older than you, your beneficiary can use YOUR remaining life rather than their own. This will give them a longer life expectancy than their own.

A detailed analysis of these and other provisions in the Final Regulations will be included in the May 2002 (and future issues) of Ed Slott's IRA Advisor newsletter. To order call 800-663-1340 or order on line at http://www.irahelp.com. Subscription is $79.95/year, 12 issues; monthly.

     -by Ed Slott, CPA
        Copyright 2002

Ed Slott, CPA
Publisher, Ed Slott's IRA Advisor
100 Merrick Road - Suite 200 East
Rockville Centre, New York 11570
(516) 536-8282

email: slottcpa@aol.com
website: http://www.irahelp.com