Articles

Client Alert - IRS Issues New Rules for Calculating IRA and Qualified Plan Distributions

By Robert J. Giordanella

Apr. 1, 2001

Introduction

In an unanticipated but welcome announcement, the IRS recently issued proposed regulations that significantly modify and simplify the rules relating to distributions from IRA's and qualified retirement plans.¹ As a result, decisions involving the designation of beneficiaries and calculation of amounts required to be distributed will be much easier to make. These rules apply to all IRA and qualified plan owners, including those who have already commenced required withdrawals.

The general rule requiring IRA owners to begin withdrawing a portion of their IRA by April 1 of the year following the year in which they attain the age of 70½, commonly referred to as the required minimum distribution or RMD, remains unchanged. However, the complicated and often incomprehensible rules relating to the methods for determining the RMD have been eliminated. Individuals no longer have to decide whether to use the term certain or recalculation method or variations thereof. In their place, the IRS has established a uniform method to calculate the RMD.

New rules

During an IRA owner's lifetime, calculating the RMD is quite simple. Each year, the owner divides the value of his or her account on the last day of the previous year by the applicable distribution period based on the owner's current age as set forth in the newly issued uniform life expectancy table. The result is the amount the owner is required to withdraw in that year. This table (a copy of which is attached to this Bulletin) provides a uniform distribution period for all persons of the same age and is to be used to determine the RMD for all IRA owners.² To further simplify this process, the proposed regulations require IRA trustees to report to the IRS and IRA owners the amount required to be distributed from the IRA. For those individuals who have more than one IRA account, the proposed regulations continue to permit the RMD to be withdrawn from any IRA account owned by the individual, notwithstanding what the IRA trustee reports to the IRS.

Upon the death of the owner, if the owner had designated a beneficiary, the remaining account balance is paid out over the remaining life expectancy of the designated beneficiary. If no beneficiary was designated, then the remaining balance must be paid out within 5 years after the owner's death if the owner dies before his required beginning date or over the remaining life expectancy of the owner if the owner dies after his required beginning date.

The proposed regulations do not change the rights of a surviving spouse who is named as the beneficiary of an IRA to rollover the full amount of the IRA into an IRA established in the spouse's name.

Illustration

The application of the new rules can be illustrated by the following example: Mr. Smith is a 75 year old widower. The value of his IRA at December 31, 2000 is $500,000. He named his son Paul as a designated beneficiary. Using the new uniform life expectancy table, the applicable life expectancy for a 75 year old individual is 21.8 years. Therefore, Mr. Smith is required to withdraw $22,935.78 ($500,000/21.8) in 2001. Assuming a 5% increase in the IRA's value and payment of the RMD was made at the end of the year, the value of the account on December 31, 2001 would be $502,000 (rounded). The applicable life expectancy for a 76 year old individual is 20.9. Thus, in 2002, Mr. Smith is required to withdraw $24,019.14 ($502,000/20.9). If Mr. Smith dies in 2003, distributions to Paul must commence before the end of 2004. The amount Paul must withdraw each year is based on Paul's remaining life expectancy, as set forth in the applicable IRS table.

Benefits

In addition to simplifying the method for calculating the RMD, the new rules provide other significant benefits to IRA owners and their beneficiaries. These include:

• The new uniform life expectancy table results in generally longer payout periods and smaller required minimum distributions, thereby deferring the receipt of taxable income. The tax savings may be significant, especially if President Bush's tax cut proposals are passed. Smaller distributions also result in a greater amount being retained in the IRA and continuing to grow tax-free.
• An IRA owner can change a designated beneficiary after his or her required beginning date without affecting the required minimum distribution amount.
• An IRA owner no longer needs to determine the beneficiary of his or her IRA by the required beginning date.
• Beneficiaries of an IRA that did not have a designated beneficiary (e.g. where an estate was named as a beneficiary of an estate) can withdraw the account over the remaining life expectancy of the IRA owner if the owner had already attained the age of 70½. Under the old rules, the beneficiaries had to withdraw the IRA balance over a much shorter time period.

Effective date of new rules

These proposed regulations are effective for distributions for calendar years beginning on or after January 1, 2002. However, the IRS has stated that IRA owners are permitted, but not required, to follow these new rules for distributions for the 2001 calendar year. For qualified retirement plans, the effective date is January 1, 2002 unless the plan is amended to permit the new rules to apply to RMD's made in 2001. Even if the plan is not amended, the IRS has adopted a procedure which effectively permits individuals to apply the new rules for 2001.

While in most cases, these new rules will benefit the IRA owner, each owner should calculate his or her RMD under both the old rules and the new rules to determine which results in a lower RMD. Further, the rules for those individuals who attained the age of 70½ in 2000 and elected to defer the first RMD until April 2001 remain complicated. If you fall into this category, please contact a member of our Trusts & Estates group listed below for an explanation of how the new rules would apply to you.

The regulations are not expected to become final until after hearings on the proposed regulations take place this summer. The regulations may be modified as a result of these hearings. Consequently, if your financial situation permits, it may be prudent to wait until later in 2001, when the final regulations are expected to be issued, to make your RMD.

Conclusion

The new IRA distribution rules have relieved many taxpayers from the annual ritual of trying to calculate how much must be withdrawn from their IRA accounts. The new rules provide a uniform, simplified method for all IRA owners to use.

For many individuals, IRA's and retirement accounts make up a substantial part of their estate and must be taken into consideration when developing an effective estate plan. Given the significant changes in the tax laws that have taken place over the past few years, individuals should evaluate whether their current estate plan is structured to take advantage of these changes. Members of our Trusts & Estates group are available to review your current estate plan and discuss with you various estate planning opportunities.

Peter R. Porcino	212-790-9208
Burt A. Lewis	212-790-9226
Morton L. Price	212-790-9254
Simon Gerson	212-790-9206
Robert Halper	212-790-9260
Robert J. Giordanella	212-790-9234
Sidney I. Liebowitz	212-790-9220
Lewis R. Cowan	212-790-9230

NEW UNIFORM LIFE EXPECTANCY TABLE

To be used by all IRA owners to calculate lifetime distributions (unless the beneficiary is the owner's spouse who is more than 10 years younger than the owner).

Age of the employee	Distribution period
70	26.2
70	26.2
71	25.3
72	24.4
73	23.5
74	22.7
75	21.8
76	20.9
77	20.1
78	19.2
79	18.4
80	17.6
81	16.8
82	16.0
83	15.3
84	14.5
85	13.8
86	13.1
87	12.4
88	11.8
89	11.1
90	10.5
91	9.9
92	9.4
93	8.8
94	8.3
95	7.8
96	7.3
97	6.9
98	6.5
99	6.1
100	5.7
101	5.3
102	5.0
103	4.7
104	4.4
105	4.1
106	3.8
107	3.6
108	3.3
109	3.1
110	2.8
111	2.6
112	2.4
113	2.2
114	2.0
115 and older	1.8

Footnotes

¹ While this memorandum focuses on IRA accounts, the new rules apply equally to distributions from qualified retirement plans.

² The only exception to this rule applies in the situation where the owner's sole beneficiary is the owner's spouse and the spouse is more than 10 years younger than the employee. In that case, the owner is allowed to use the more favorable joint life and last survivor life expectancy tables.

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