DRAFT

The Minimum

Distribution Rules Affecting IRAs and Qualified Plans (QSPs)
In a Nutshell
(After Final Regulations)
A Guide for the Perplexed

ARTICLE 1
Overview and Terminology

This brief article is an overview only. I cannot in a few pages possibly explain all the intricacies of the minimum distribution rules, and so you should not rely on this article alone, without consulting a competent tax advisor first. Estate planning for distributions from qualified plans and IRAs is a difficult subject to which I have devoted over one thousand pages in a treatise entitled Distribution and Estate Planning For Deferred Compensation and IRA Benefits, which can be found at www.TrustsAndEstates.net. (Go to the “Guides and Articles” page.) Nevertheless, it is my intention that the following brief explanation will be of benefit in helping you understand generally the issues at stake.

As most Americans know by now, the Internal Revenue Code (IRC[1]) requires that qualified plan participants and IRA-Owners (which I will sometimes refer to in this article generically as “Participants”), and their beneficiaries, take certain minimum required distributions (MRDs) from their qualified plans or IRAs. When you, the Participant (herein sometimes “P”), or your death beneficiary (herein sometimes “B”) take a distribution from a qualified plan (herein sometimes “QP”), tax sheltered annuity, IRA, etc., it becomes subject to income tax, usually for the first time.[2] Until distributed, the Government cannot tax it.[3] This is the reason the minimum distribution rules exist: so that you and your beneficiaries will not be able to postpone income taxation forever, accumulating income on a tax deferred compounded basis in the meantime.

IRC §§401(a)(9)(A), 403(b)(10), 408(a)(6), 457(d)(2) and 4974 require that QPs, IRAs, certain commercial annuities, and 403(b) (tax sheltered annuity plans), etc. (herein sometimes referred to as Qualified Savings Plans[4] or QSPs), make certain Minimum Required Distributions (MRDs), beginning no later than your “Required Beginning Date” (or RBD), if you are alive at that time. The RBD is April 1 of the calendar year following the calendar year you reach age 70½.[5] However, beginning in 1997, your RBD under a QP is extended until retirement, if later, if the plan allows for it and if you are not a “5% owner.”[6] Note that this rule has no application in the case of an IRA. 403(b) plans may have a special RBD as well.

A Participant’s beneficiary is required to begin taking distributions shortly after the death of the Participant (there is a special rule if the beneficiary is the surviving spouse, however). Now that we have all of the abbreviations, acronyms, and the nomenclature, out of the way, I can proceed less technically.

On April 16, 2002, after almost 16 years, the IRS published final regulations[7] governing this complicated area, an area of the law that affects no telling how many millions of us. The old MRD rules were based on who your death beneficiary was, and that was determined at the date of death or RBD, whichever was first. The new MRD rules are still based upon who your death beneficiary is, but not as long as you are alive.^{^[8]} So long as you are alive, there are no deadlines, and you can change your beneficiary without penalty as often as you like, without affecting your lifetime MRDs.

ARTICLE 2
EFFECTIVE DATE OF THE Final REGULATIONS

According to the Preamble to the final regulations, “[t]he regulations apply for determining required minimum distributions for calendar years beginning on or after January 1, 2003. For determining required minimum distributions for calendar year 2002, taxpayers may rely on these final regulations, the 2001 proposed regulations, or the 1987 proposed regulations.”

ARTICLE 3
DISTRIBUTIONS DURING LIFE

3.1 The Uniform Lifetime Distribution Table.

With one exception, as long as the participant (herein sometimes “P”) is alive, the payout schedule is the same for everyone who is the same age, regardless of who the beneficiary is.

Under the new rules, the beneficiary designation is all but irrelevant during P’s life. The only case where the beneficiary designation is relevant is where B is a spouse who is more than 10 years younger than P. So, putting aside the special case just mentioned, everyone who is the same age is on the same payout schedule during life, following the RBD. That payout schedule is our old friend the minimum distribution incidental benefit (MDIB) table. The MDIB table returns the life expectancy of the participant and a person (not a beneficiary) who is ten years younger than the participant, recalculating both lives each year. It is that simple. The one exception is if P is married to a spouse who is more than ten years younger than P, and if that spouse is P’s beneficiary, then P can use the annually recalculated age of P and B. These rules are very favorable. In fact, during life, it is only with great difficulty that I can come up with a fact pattern that would make the old rules more favorable.

Basically, beginning with the year you turn 70½ (in most cases), you compute your MRD by taking your account balance under your QSP as of the last valuation date (December 31, in the case of an IRA), and dividing that balance by the Distribution Period set forth under the Uniform Table, reproduced below.

Uniform Lifetime Table[9] (Applies Only While the Participant is Still Alive)

Age of employee	Distribution period	Note: The Percentages Below Were Added by Me	Age of employee	Distribution period	Note: The Percentages Below Were Added by Me
70	27.4	3.65%	94	9.1	10.99%
71	26.5	3.77%	95	8.6	11.63%
72	25.6	3.91%	96	8.1	12.35%
73	24.7	4.05%	97	7.6	13.16%
74	23.8	4.20%	98	7.1	14.08%
75	22.9	4.37%	99	6.7	14.93%
76	22.0	4.55%	100	6.3	15.87%
77	21.2	4.72%	101	5.9	16.95%
78	20.3	4.93%	102	5.5	18.18%
79	19.5	5.13%	103	5.2	19.23%
80	18.7	5.35%	104	4.9	20.41%
81	17.9	5.59%	105	4.5	22.22%
82	17.1	5.85%	106	4.2	23.81%
83	16.3	6.13%	107	3.9	25.64%
84	15.5	6.45%	108	3.7	27.03%
85	14.8	6.76%	109	3.4	29.41%
86	14.1	7.09%	110	3.1	32.26%
87	13.4	7.46%	111	2.9	34.48%
88	12.7	7.87%	112	2.6	38.46%
89	12.0	8.33%	113	2.4	41.67%
90	11.4	8.77%	114	2.1	47.62%
91	10.8	9.26%	115+	1.9	52.63%
92	10.2	9.80%
93	9.6	10.42%

3.2 Your First MRD.

Distributions are ordinarily due on December 31 of the Distribution Calendar Year, based on values as of the preceding year (the Valuation Calendar Year), except in the case of the first distribution. During lifetime, the basic rule is that you need not take any distributions until April 1 of the calendar year after you reach age 70½ (your “Required Beginning Date” or RBD). In the case of a QP, the RBD is the April 1 following retirement, if later and if you are not a 5% owner. The calendar year in which you turn age 70½ (or retire, if later and if applicable) is called the “First Distribution Calendar Year.” The next year is the “Second Distribution Calendar Year.” You should note that your RBD occurs in the Second Distribution Calendar Year (rather than in the First), which makes it unusual.

The amounts that are required to be distributed are calculated based on the adjusted value of your accrued benefits (account balance) as of the last valuation made prior to the beginning of the Distribution Calendar Year (the “Valuation Calendar Year”). In the case of an IRA, you simply determine its value on December 31 of the preceding calendar year, in order to determine the minimums.[10] In the case of other QSPs, the rules are more complex.[11]

The first distribution, instead of being due on December 31 of the calendar year after you reach age 70½, is not due until the following April 1 (your RBD). This means you may need to take two minimum distributions in the Second Distribution Calendar year: one by April 1, and the second by December 31. In each year thereafter, you will only need to take one distribution a year, due no later than December 31.

So, the first minimum distribution is due no later than the RBD,[12] and the second minimum distribution is due by December 31 of the same year.[13] This can result in some doubling up or bunching of income in the year that contains the RBD; therefore, some people take the first distribution in the year they turn 70½, to keep a more even payout schedule and to take advantage of lower marginal income tax rates, and because, contrary to the old rule, “[a]n employee's account balance for the valuation calendar year that is also the employee's first distribution calendar year is no longer reduced for a distribution on April 1 to satisfy the minimum distribution requirement for the first distribution calendar year.”[14] Each minimum distribution after the first one is due by December 31, based upon the value as of the end of the preceding valuation year. (Phew!) One reason that these rules are important to know is that the penalty for failure to take the distribution is 50% of the amount required to have been distributed.[15]

The distribution period, which is based on your age, is not determined on the RBD.[16] Rather, the distribution period (a function of age) is first determined as of the last day of the first distribution calendar year. Another way to articulate the rule is to say that the distribution period is determined on your birthday in the year you reach 70½. So if you turn 70½ in the second half of the year, you would be age 70 in the first distribution calendar year. Contrariwise, if you turn 70½ in the first half of the year, you would be age 71 in the first distribution calendar year. Put yet another way, participants with birthdays during January through June will be 70, and participants with birthdays during July through December will be 71, in the first distribution calendar year, and the first distribution period (factor) will be 27.4 and 26.5, respectively.

Although the life expectancy of a 70 year old under the Government tables is 17 years, and the life expectancy of a 71 year old is 16.3 years, under the new rules, the distribution period for a 70 year old is 27.4 years, and the distribution period of a 71 year old is 26.5 years, regardless of who the beneficiary is (unless B is a spouse who is more than ten years younger than P). To calculate the MRD for any given year, you take the closing account balance as of December 31 of the prior year (in the case of an IRA) and divide it by the distribution period under the uniform table in the year of withdrawal.

3.3 No Lifetime MRDs For Roth IRAs.

The MRD rules do not apply to Roth IRAs[17] during the life of the IRA owner. This is one of several advantages that a Roth IRA has over regular IRAs. See the “Guides and Articles” page on my web site for a detailed (ad nauseam) treatment of the Roth IRA: http://www.trustsandestates.net/ My Roth IRA article is over 100 pages, is very technical, and was prepared mainly for lawyers and accountants. If you are interested in Roth IRAs, I recommend that you visit http://www.rothira.com/. At this site, you will find articles that are accessible and easy to understand, as well as articles of a more technical nature. (Some of my articles are found at this site as well.) The site also offers free Roth IRA calculators to help you decide if a Roth IRA will work for you.

ARTICLE 4
Distributions AFTER DEATH

At your death, the beneficiary designation becomes significant. Or, more precisely, the persons who are your beneficiary(ies) on September 30 of the year following your death (the beneficiary determination date or BDD) determine the post-death payout period. Following your death, your beneficiary will have to consult a new table (reproduced below), where the distribution period is the beneficiary’s age in the year after your death, subtracting one for each year thereafter. If your beneficiary is your spouse, your spouse can rollover and defer taking benefits until your spouse turns 70½; or not rollover, and defer until you would have been 70½. Also, a spouse can recalculate life expectancy each year, if there is no rollover.

4.1 Where There is a Designated Beneficiary.[19]

4.1(a) If there is a nonspouse Designated Beneficiary.

If there is a nonspouse Designated Beneficiary,[20] post-death MRDs can generally be made over the life expectancy of the beneficiary, determined in the year after death, subtracting one from that number for each year thereafter.[21] This is true whether death is before or after the RBD. However, if death is after the RBD, the MRD can be computed as if there were no beneficiary, if this produces a better result, which might be the case if the beneficiary were older than the participant.

4.1(b) If the sole death beneficiary is the participant’s spouse.

If the sole death beneficiary is the participant’s spouse, then whether the participant dies before or after the RBD, post-death MRDs can generally be made over the life expectancy of the spouse, redetermined annually for so long as the spouse is living. However, if P dies before the RBD, then distributions do not need to begin to the surviving spouse until the year the participant would have turned 70½ (or the year after death if later). When the spouse dies, recalculation no longer applies (which is a good thing, for obvious reasons), and we take, instead, the spouse’s life expectancy in the year of death and subtract one from it for each year thereafter. As presaged above, if the participant died prior to the participant’s RBD, a special rule for spouses permits distributions to be deferred until the participant would have reached 70½. (This rule actually has a number of complications; so be forewarned.) Finally, note that if P’s spouse is the death beneficiary, the spouse can rollover the benefit and treat it as his or her own IRA. Moreover, in some cases, the regulations will “deem” a spouse to have made a rollover, whether the spouse likes it or not. (Note that this is not as favorable as a rollover, even during the spouse’s life, because under a rollover we get to use the Uniform Table, which is derived by using the joint life expectancy of the spouse and a hypothetical person who is ten years younger than the spouse, re-determined annually.)

4.1(c) If there is a Designated Beneficiary, and death is before the RBD.

If there is a Designated Beneficiary, and death is before the RBD, then, notwithstanding the rule that MRDs are made over the life expectancy of the beneficiary (see above), it may be that the MRDs can be made under the 5-Year Rule, but only if the QSP allows for it and it is elected. The QSP can even require that all pre-RBD post-death distributions be made under the 5-Year Rule. If the QSP says nothing, then the 5-Year Rule is not available if there is a designated beneficiary.

4.2 Where There is No Designated Beneficiary.

4.2(a) If there is no Designated Beneficiary, and death is after the RBD.

If there is no Designated Beneficiary, and death is after the RBD, then post-death MRDs can be made over the life expectancy of the participant, determined in the year of death, subtracting one from that number for each year thereafter. Note that the life expectancy for this purpose is determined under Table V of IRC §1.72-9, and is not the more favorable MDIB Uniform Table applicable during life.

4.2(b) If there is no Designated Beneficiary, and death is before the RBD.

If there is no Designated Beneficiary, and death is before the RBD, then post-death MRDs must be made under the 5-Year Rule[22] (Note that if there is no designated beneficiary a much more favorable MRD schedule is likely to occur if death is after the RBD then if before.)

4.3 The Spousal Rollover Rule.

If your spouse is your beneficiary, your spouse can rollover the distribution (if the QSP allows for this), and treat the rolled over distribution as if it belonged to your spouse all along; in which case, the minimum distribution rules are applied with reference to the age of your spouse. At your spouse’s death (or more precisely, December 31 of the year after death), the MRDs are a function of whether or not your spouse has designated an individual as a beneficiary. In other words, following the rollover, the rule is the same as if the spouse were the participant. By use of the spousal rollover technique, income taxes can be postponed for many, many years.

A very common technique is to leave your QSP interest to your spouse outright. This has very good income tax consequences, even if the estate tax consequences are not ideal.[23] Your spouse can then rollover your QSP interest into an IRA of his or her own, and name your (mutual?) descendants as your spouse’s death beneficiary. (Obviously, this only works well if your descendants and your spouse’s descendants are the same.) The minimum payout period that you were stuck with while living is now all forgotten, and the new payout period will begin when your spouse reaches 70½, or after the rollover if later, and it will be based not upon your life expectancy, but upon the distribution period described in the uniform table using your spouse’s age, which could be longer. The advantage is primarily at the death of the spouse, because in that case the life expectancy of the spouse’s beneficiaries can be used. In effect you get yet another fresh start. Incidentally, this technique is possible because a surviving spouse (and only a spouse) has the right to rollover IRA benefits inherited from a deceased spouse into a new IRA.

4.4 The Life Expectancy Multiples Post-Death.

The life expectancy multiples for post-death distributions, where there is a designated beneficiary are determined under Table V of IRC §1.72-9. So that you won’t have to look it up, here are the Table V rates referred to above. I added the percentages. This is also the table to use to first determine the life expectancy of the participant in the year of death, where there is no designated beneficiary.

The following table, referred to as the Single Life Table, is used for determining the life expectancy of an individual after the participant has died. [24]

Single Life Table (Applies After Death of the Participant)

Age	Life Expectancy	Note: The Percentages Below Were Added by Me	Age	Life Expectancy	Note: The Percentages Below Were Added by Me	Age	Life Expec- tancy	Note: The Percentages Below Were Added by Me	Age	Life Expectancy	Note: The Percentages Below Were Added by Me
0	82.4	1.21%	29	54.3	1.84%	58	27.0	3.70%	87	6.7	14.93%
1	81.6	1.23%	30	53.3	1.88%	59	26.1	3.83%	88	6.3	15.87%
2	80.6	1.24%	31	52.4	1.91%	60	25.2	3.97%	89	5.9	16.95%
3	79.7	1.25%	32	51.4	1.95%	61	24.4	4.10%	90	5.5	18.18%
4	78.7	1.27%	33	50.4	1.98%	62	23.5	4.26%	91	5.2	19.23%
5	77.7	1.29%	34	49.4	2.02%	63	22.7	4.41%	92	4.9	20.41%
6	76.7	1.30%	35	48.5	2.06%	64	21.8	4.59%	93	4.6	21.74%
7	75.8	1.32%	36	47.5	2.11%	65	21.0	4.76%	94	4.3	23.26%
8	74.8	1.34%	37	46.5	2.15%	66	20.2	4.95%	95	4.1	24.39%
9	73.8	1.36%	38	45.6	2.19%	67	19.4	5.15%	96	3.8	26.32%
10	72.8	1.37%	39	44.6	2.24%	68	18.6	5.38%	97	3.6	27.78%
11	71.8	1.39%	40	43.6	2.29%	69	17.8	5.62%	98	3.4	29.41%
12	70.8	1.41%	41	42.7	2.34%	70	17.0	5.88%	99	3.1	32.26%
13	69.9	1.43%	42	41.7	2.40%	71	16.3	6.13%	100	2.9	34.48%
14	68.9	1.45%	43	40.7	2.46%	72	15.5	6.45%	101	2.7	37.04%
15	67.9	1.47%	44	39.8	2.51%	73	14.8	6.76%	102	2.5	40.00%
16	66.9	1.49%	45	38.8	2.58%	74	14.1	7.09%	103	2.3	43.48%
17	66.0	1.52%	46	37.9	2.64%	75	13.4	7.46%	104	2.1	47.62%
18	65.0	1.54%	47	37.0	2.70%	76	12.7	7.87%	105	1.9	52.63%
19	64.0	1.56%	48	36.0	2.78%	77	12.1	8.26%	106	1.7	58.82%
20	63.0	1.59%	49	35.1	2.85%	78	11.4	8.77%	107	1.5	66.67%
21	62.1	1.61%	50	34.2	2.92%	79	10.8	9.26%	108	1.4	71.43%
22	61.1	1.64%	51	33.3	3.00%	80	10.2	9.80%	109	1.2	83.33%
23	60.1	1.66%	52	32.3	3.10%	81	9.7	10.31%	110	1.1	90.91%
24	59.1	1.69%	53	31.4	3.18%	82	9.1	10.99%	111+	1.0	100.00%
25	58.2	1.72%	54	30.5	3.28%	83	8.6	11.63%
26	57.2	1.75%	55	29.6	3.38%	84	8.1	12.35%
27	56.2	1.78%	56	28.7	3.48%	85	7.6	13.16%
28	55.3	1.81%	57	27.9	3.58%	86	7.1	14.08%

4.5 The 5-Year Rule and Its Exceptions — Death Prior to the RBD.[25]

4.5(a) The 5-Year Rule Has No Application If Death is After the RBD.

Recall that the 5-Year rule has no application if death is after the RBD. If death is after the RBD and there is a human being designated beneficiary, then the installment method is usually available, using the life expectancy of the beneficiary as the measuring life, as in the case where death is before the RBD. However, if death is after the RBD and there is no human being designated as beneficiary, then the default rule is that you get to use an installment payout using the participant’s life expectancy in the year of death, subtracting one for each year thereafter. On the other hand, if death is before the RBD and there is no human being designated as beneficiary, then the basic 5-year rule applies, described below.

4.5(b) The Basic 5-Year Rule.

To recapitulate more specifically what was stated broadly above, the IRC states as the general rule (which is really the exception) that if you die prior to your Required Beginning Date[26] (RBD), your entire interest in the QSP must be distributed (and taxes paid) by December 31 of the calendar year that contains the fifth anniversary of your death.[27] This is the “5-Year Rule”.

4.5(c) The Exception to the 5-Year Rule.

If either an individual or a qualified trust is the beneficiary of your interest (which for most people is the general rule rather than the exception, the IRC characterization notwithstanding), then, if death is prior to the RBD, the benefit is paid over the life or life expectancy of the beneficiary,[28] unless the QSP provides that the 5-year rule will apply instead. Interestingly, the 5-year rule may not even be an option, if an individual has been designated as the beneficiary.[29]

Under the exception to the 5-year rule, a 35 year old beneficiary could receive distributions over 48 years, which will allow for a considerable deferral of income tax.

4.5(d) The Exception to the Exception to the 5-Year Rule.

If the designated beneficiary is your spouse, distributions need not begin any earlier than the end of the calendar year in which you (P) would have attained age 70½ (or the end of the calendar year following the year of death, if later).[30]

4.5(e) The Exception to the Exception to the Exception to the 5-Year Rule.

If the designated beneficiary is your spouse, then under IRC §§402(c)(9), 403(b)(8)(B) or 408(d)(3)(C), as the case may be — the spousal rollover/inherited IRA rules, — your spouse may treat the interest as his or her own (in the case of an IRA) or roll it over in all cases.In such a case §401(a)(9) will apply solely with reference to the surviving spouse.[31] This should permit the spouse to defer distribution until the April 1 of the calendar year following the calendar year in which the spouse attains age 70½.[32]

4.5(f) Regulatory Exception For Annuity Distributions Irrevocably Commencing Prior To The RBD.

The regulations provide that if distributions irrevocably (except for acceleration) commence to an employee before the RBD over a period permitted for distributions after the RBD, and the distribution is in the form of a special annuity, then distributions will be considered to have begun on the actual commencement date, even if the employee dies before the RBD.

* * * *

ARTICLE 5
Some Numbers.

NOTE: These numbers need revision in light of the new Mortality Tables. I just haven’t gotten around to re-computing them yet. I expect that the trend line will be the same though.

5.1 Some Typical Return Multiples.

The MDIB Table returns 26.2 for a 70 year old (3.8%), 21.8 for a 75 year old (4.6%), 17.6 for an 80 year old (6%), 10.5 for a 90 year old (9.5%), and 1.8 for anyone 115 or older (55.6%). Thus, if the growth in value of the IRA account was 9.5% each year (admittedly not likely), it would be twenty years after the person turns 70½ before the MRD for the year would be more than the growth. At 6%, it would be ten years. At age 87, the MDIB factor is 12.4 or 8.1% of the prior year-end account balance. 8% is not an unreasonable expected return, though who knows?

5.2 $1 Million at Age 70.

To give you an idea of what to expect, if you began with $1 million at age 70, your age in the first distribution calendar year (FDCY), and made an 8% return year in and year out (my friend Bruce Tempkin will tell you it doesn’t work like that, but we are talking rule of thumb here), your IRA would be worth more than $1.5 million by the time you turn 87, under the new rules. Your running total of minimum distributions would be a little over $1.3 million. If you paid 40% income tax on those distributions, and invested the difference at a 6.4% average after tax rate of return in an outside account, that account would be worth (and the basis would be) just under $1.3 million when you are 87.

5.3 $500,000 at Age 55.

Here is another example. If you have $500,000 in an IRA at age 55 earning 8% interest, and if you never contribute another dime to it, you should have around $1.5 million in the year you turn 70½. If you take only the MRDs, you will have about $2.3 million in the IRA on your 87th birthday. In that year, your minimum distribution will be approximately $190,000. Further, by this time (age 87) our assumption is that you will already have withdrawn (and been taxed on) close to $2 million in the form of MRDs. If after paying 40% in income taxes, the amount left over were able to grow at a net average after-tax rate of 6.4%, you would have, in a hypothetical outside account, and after tax, an amount about equal to the $2 million you withdrew. (In other words, if you didn’t spend the MRDs and reinvested them after-tax, you would have close to $2 million in an outside account at age 87, with a basis equal to its value, and roughly $2.3 million in your IRA, as yet untaxed.) You can leave both the IRA ($2.3 million) and the outside account ($2 million) to your spouse, not paying either income or estate taxes, and your spouse can leave what is left to the children, postponing income taxes over their life expectancies in the case of the IRA (first determined in the year of your spouse’s death), but owing estate tax on the principal, as in the case of any other asset.

5.4 The Proof.

To see the proof, download the Excel spreadsheet found at http://www.trustsandestates.net/Excel.htm (or it can be downloaded directly, simply by clicking http://www.trustsandestates.net/Excel/MRDTables.xls, and plug in the variables. Other free and occasionally useful Excel spreadsheets may be found at http://www.trustsandestates.net/Excel.htm.

5.5 Quibbling with the Assumptions.

One may quibble with the assumptions, but the principles illustrated are sound. Through proper planning, your IRA can be sheltered from income taxation for a long time, and need not be taxed at your death. Postponing income taxation is a substantial advantage, due to the effects of the tax deferred compounding of interest, as I hope the above examples amply illustrate.

5.6 Some Conclusions About The New Rules.

In conclusion, the most noticeable advantage of the new rules is that the benefits during life are enhanced, in some cases substantially, in those cases where the beneficiary is not more than 10 years younger than the participant. Another huge advantage is that under the new rules the participant can change beneficiaries back and forth at will during life without prejudice. The fact that we get to recalculate the beneficiary’s life (in effect) in the year after the participant’s death is icing on the cake.

5.7 The Penalty For Getting It Wrong.

The penalty for failing to take an MRD when due is a tax equal to 50% (!) of the MRD that should have been taken. For this reason, and because there are many, many, nuances and exceptions to the rules described above, which will vary depending on your individual situation, most participants and beneficiaries should consult a qualified tax advisor to assist in developing a reasonable strategy for taking distributions from QSPs and to help determine what the MRD will be.

ARTICLE 6
Trust As Beneficiary

Trusts (including marital deduction trusts) can be beneficiaries of QSPs, but here special care is called for, and the area is subject to a number of uncertainties.

As a general rule, in order to use the joint life expectancy method during life, or the life expectancy method (instead of the five year rule) after death, the beneficiary must, using the phraseology of the IRC, be a “designated beneficiary,” which basically means that the beneficiary must be a human being. Thus, an estate is not a “designated beneficiary” nor is a charity or other legal entity. Nevertheless, the beneficiaries of a trust can be treated as designated beneficiaries if the trust meets certain requirements set forth in the final regulations. This is called the “look-through” rule because you are permitted to look through the trust, treating the beneficiaries of the trust as beneficiaries of the IRA or QP, rather than the trust itself.

To paraphrase the regulations: “[A] trust itself may not be the designated beneficiary even though the trust is named as a beneficiary.” However, if a trust is named as the beneficiary, the beneficiaries of the trust will be treated as designated beneficiaries under certain conditions:

The trust must be valid under state law, or would be but for the fact that there is no corpus.
The trust is irrevocable or will, by its terms, become irrevocable upon the death of the employee.
The beneficiaries of the employee’s interest under the trust must be identifiable from the trust instrument.
Certain documentation (e.g., a copy of the trust itself or a certification as to the terms and beneficiaries) must be provided to the QSP administrator.
If death is prior to the RBD, and depending on whether the trust agreement itself is delivered or whether a certification of the beneficiaries is delivered, the employee must “agree” that if the trust instrument is amended at any time in the future, the employee will, within a reasonable time, provide a copy of each such amendment, or provide a corrected certification, as the case may be.

There are as yet many unresolved issues regarding the use of trusts as beneficiaries, and a trust should only be named with extreme care and appreciation of the risks. To give just a few of many problems:

The fact that the beneficiaries must be ascertainable makes the use of formula clauses somewhat problematic, as does the existence of discretion regarding funding, as does the conferring of a power of appointment on a beneficiary.
If the IRA proceeds can be used, either directly or through the trust, for the payment of debts, expenses or taxes, then perhaps not all of the beneficiaries of the trust are “designated beneficiaries” (i.e., human beings).
Naming a marital deduction trust as beneficiary invokes not only minimum distribution compliance issues, but marital deduction compliance issues as well.[33]
The final regulations say that we can ignore “a mere potential successor” beneficiary under the trust for purposes of determining the beneficiary with the shortest life expectancy, but, unfortunately, the regulations do not give us the foggiest notion of who would fall into that class. At one time, conversations with people who have had conversations with people who know people in the Treasury Department, led some to believe that the IRS’ informal and unwritten position was that a trust would not qualify unless it was certain that the trust would pay out the QSP proceeds during the life expectancy of the primary beneficiaries, if the beneficiary should live so long (or some variation of this rule involving the life expectancies of unborn siblings of the designated beneficiaries and Lord only knows what else). This is a rule we could live with. However, this conclusion is not, in my opinion, remotely to be extracted from, much less a reasonable reading of, the regulations; moreover PLR 20028025 throws doubt on even this rule.

In that PLR, a trust was set up for a couple of little children until age 30. If they both died before then, the trust passed to their children. Only if both children died without descendants before age 30 would there be a need to consider who would take. In fact, the trust provided that in the extremely unlikely event that both children died without issue before age 30 the trust would pass to a 67 year old great-uncle. According to the IRS, he life expectancy of the great-uncle was to be the measuring life. Since one would ordinarily expect that the actuarial likelihood of the both children dying before age 30 would make the great-uncle a mere remote possible successor, one would have thought we could ignore him. Further, since all descendants in all trusts can always die before the trust terminates, even if it only lasts 5-minutes, one wonders just where the line is to be drawn.

Trusts are a staple of the estate planner’s toolkit, and few of us are willing to eschew using trusts as beneficiaries until such time as the IRS develops a written policy. We have been waiting for 16 years already. Nevertheless, in the present milieu, and without really knowing the secret IRS position on the subject of trusts as beneficiaries, there is some risk involved whenever a trust is named. PLR Since there are many good reasons why it is often necessary or desirable to name trusts as beneficiaries, it is simply a judgment call whether to take these IRS rumors seriously or not, and if taken seriously, what exactly to do about it.

The IRS has all but stated that a generation skipping transfer tax (GSTT) exempt trust (a dynasty trust) will never qualify for look-through treatment. Perhaps it is because a dynasty trust that continues for so long as the law allows will of necessity violate one or more of the rules just described. However, it is impossible to be more specific in ascribing an actual reason, and it may be that the IRS position is based on no more than a generalized hostility to families with the wherewithal to establish a GSTT exempt trust.

ARTICLE 7
Community Property Considerations

If the money that is in your QSP is community property, which it will be to the extent earned in a community property state while you were married to your spouse, absent a marital agreement to the contrary, then your spouse may have the right, exercisable by will, to dispose of his or her community property interest in the your IRA. This right is almost certainly present in the case of an IRA (unless your state law provides otherwise), but in the case of other QSP the right will be preempted by ERISA,[34] if ERISA applies, which it usually will.

If your spouse leaves his or her community property interest in your QSP to someone other than you, there will be questions and issues to address that are not easy to solve. For instance: Who is taxed for income tax purposes on distributions from your IRA to someone other than you (e.g., the residuary beneficiary under your spouse’s will)? Who pays the premature distribution tax if you are under age 59 ½ at the time of a distribution to someone other than you? To what extent is your IRA liable for your spouse’s estate taxes? If you are over 70 ½, do you get minimum distribution credit for distributions to your spouse’s beneficiaries?

ARTICLE 8
WARNINGS

8.1 Limitations Under The QSP.

All of the various options discussed above can be altered or lost, depending on the terms of the QSP and the form of the beneficiary designation, both of which are critical and require careful planning.

8.2 An IRA is a Far Superior Source of Payments to Your Beneficiaries Than Are Other Qualified Savings Plans.

The alternatives available under an IRA are unlimited. And, by making an IRA to IRA transfer, you can end up in an IRA that offers the distribution alternatives suitable to your needs. An IRA is not subject to the joint and survivor annuity rules applicable to some QPs, and you can generally name any beneficiary you desire, unlike most QPs.

If the beneficiary of your QP is your spouse, your spouse may be able to rollover the inherited interest to an IRA,[35] but any other beneficiary will be stuck.[36] If the QP does not allow installment distributions to your nonspouse beneficiaries, your beneficiaries could be facing a tax nightmare. Moreover, consider what happens should the QP terminate or the employer goes out of business. In that case your nonspouse beneficiary may have no choice but to pay income taxes on the entire benefit in one year![37]

8.3 The Assumption of Some Risk is to Be Expected, But You Should First Be Made Aware of Your Options.

Unfortunately, estate planning for distributions from QSPs, involving as it does reading the QSP document itself, completing a beneficiary designation form properly, seeing to it that it is accepted by the sponsor, etc., is very time consuming,[38] and so many clients assume at least some of the burdens and risks involved in overseeing these matters themselves, perhaps with the assistance of the QSP sponsor and a tax lawyer or other professional advisor. This is understandable and perhaps necessary, as a matter of practical economics. Be advised, however, that there are very few people who are familiar enough with this extremely complicated area to give you reliable and informed advice, and so attempting to arrive at an appropriate decision without competent tax counsel is a decision you may regret.

ARTICLE 9
Completing the Beneficiary Designation Form

As indicated above, so long as you are alive, the minimum distribution rules are no longer keyed to your beneficiary designation. However, at death they are.

Once you have reached an appropriate decision about who should be your beneficiary, you may wish to fill out your own beneficiary designations, or see to it that one is completed with the assistance and advice of an attorney. You should probably assume the risk that whatever beneficiary designation is completed may not be accepted by the sponsor. The degree of risk you wish to assume is up to you. I have, however, found that most form beneficiary designations are inadequate to cover all contingencies involved, some of which are very important, and therefore prefer to prepare one of my own, for my clients to sign, with the client doing the leg work necessary to see to it that the sponsor accepts the designation.

For the do-it-yourselfers, here are a few suggestions, given on the understanding that I am not recommending a do-it-yourself approach, but recognizing that no matter what the risks, you may be unwilling to pay a lawyer $1000 or more per IRA to do this for you:

Primary Beneficiary: My death beneficiary is my spouse, if my spouse survives me. If, however, my spouse disclaims in whole or in part, the disclaimed death benefit will pass to the trustee, in trust, of the [name of the bypass/credit shelter trust or Subtrust under your Will or Living Trust].

Contingent Beneficiary: If my spouse does not survive me, then my death beneficiaries are my descendants who survive me, per stirpes.

Withdrawal Rights of Beneficiary: Except as otherwise limited by the terms of the IRA [Plan], my beneficiary will have the unrestricted right to withdraw all or any part of the death benefit from time to time, or all at once at any time, and may elect any form of payout.[39]

Beneficiary Designations by Beneficiary: If a beneficiary survives me, but dies prior to the complete withdrawal of the beneficiary’s interest, the interest not withdrawn will be paid to the beneficiary’s personal representative, as part of the beneficiary’s general probate estate, at such time and in such form as the personal representative elects and as otherwise permitted by the IRA [Plan].

Even if a lawyer is not actually implementing the designation, you should at least check to see if the above language is suitable. Depending on the terms of the QSP, and depending on your individual circumstances, the above language may not be suitable. That is why professional assistance is to be preferred. Note that if you live in a community property state, the beneficiary designation may entirely fail to address the question of what happens to your spouse’s community half interest in your IRA at your spouse’s death!

ARTICLE 10
Estate Taxes

The above discussion paid scant attention to the question of estate taxes. If your spouse is your beneficiary, it may be that you will be entitled to an estate tax marital deduction, but only if it is clear that the spouse has the right under all contingencies to draw down the benefit, or unless some other special exception applies. Often times it is not at all clear that a marital deduction will be available. Also, if the QSP contains community property, which it almost certainly will in most cases, then if your spouse dies, your spouse’s interest in your QSP will pass under the terms of your spouse’s will, ordinarily, and therefore, whether or not that entitles your spouse to an estate tax marital deduction may depend on the terms of the will.

Do not overlook the fact that an income tax deduction, under IRC §691(c), may be available for the estate tax attributable to a QSP. Unfortunately, the deduction does not cover state inheritance taxes and is not available until the income is recognized.

ARTICLE 11
Rollovers, Transfers and aggregation of QSPs

It is important to distinguish a rollover from a transfer. The rollover rules can be very technical, though they are much less so than they used to be. Suffice to say for now that a rollover must be made within 60 days of receipt of a distribution, and only one rollover can be made each year. (This is a generalization.) Rollovers between dissimilar QSPs are only allowed in special circumstances. A death beneficiary is not allowed to make a rollover, unless the beneficiary is the participant’s spouse.

A transfer between IRAs or between QPs can be made more than once a year, and on behalf of any beneficiary. The problem is that the administrator or trustee of QSP other than an IRA is usually not going to allow a transfer, unless it is a small QP under the control of the family. IRA to IRA transfer are commonly made without too much effort.

For MRD purposes, a transfer is not considered as a distribution. A distribution cannot be rolled over unless the MRD for the year has first been made, because an MRD cannot be rolled over. So, it would not be permissible to distribute an IRA entirely in January, and roll it over entirely in February, without withholding from the rollover the MRD which was technically not due until December! On the other hand, the entire account could be transferred.

IRAs can be aggregated for purposes of satisfying the MRD rules, so that the MRD for all can be taken from one or more, provided the IRAs are all of the same kind. An IRA in which a person is the death beneficiary cannot be aggregated with an IRA of which the person is the named IRA owner.

Other QSPs cannot be aggregated. Thus, if an IRA was transferred in its entirety to a new IRA, the MRD for the old IRA could be satisfied out of the new one. No harm; no foul. But if another form of QSP transferred the entire balance, there could be a problem, because a transferee QSP cannot be aggregated with the transferor QSP for purposes of satisfying the MRD rules, unless the QSPs are IRAs.

[1] All references herein to the “IRC” are to the Internal Revenue Code of 1986, as amended, unless otherwise indicated.

[3]There is an exception at death, in the case of the estate tax.

[4] I had a tough time coming up with a term to describe both IRAs and qualified plans. The term “qualified retirement plan” could be used to describe an IRA, but a “qualified plan” is a term used almost exclusively to refer to employer sponsored pension plans, exempt from tax under IRC §401, rather than §408, the IRA section. Moreover, neither a §401 pension benefit plan nor a §408 IRA, is strictly speaking a “retirement” plan, since the benefits of tax deferral can often be utilized before or after retirement. I chose, reluctantly and for the time being, the generic phrase “Qualified Savings Plan (QSP)” to refer to both IRAs and qualified plans.

[6]§1404 of the Small Business Job Protection Act of 1996(the JPA, H.R. 3448)

[7] For an annotated copy of all 100 plus pages, go to http://www.trustsandestates.net/mrd_regs.htm.

[8] The only exception is if P’s beneficiary is P’s spouse who is more than 10 years younger than P.

[9] This is the all important, all controlling, Uniform Table, that applies regardless of who the beneficiary is or whether there even is a beneficiary. The only time the Uniform Table is not relevant during life is if the participant’s spouse is the sole beneficiary and if the spouse is more than ten years younger than the participant.

The table is slightly more taxpayer helpful than the table we had before, which was compiled using out-dated, and generally more unfavorable, mortality statistics.

[11]As a general rule, in a defined contribution plan (an individual account plan), one looks to the value of the account balance as of the last valuation date in the calendar year preceding the distribution calendar year (the valuation calendar year)(Treas. Reg. §1.401(a)(9)-5 Q&A 3(a)) adjusted by increasing the account balance by any contributions or forfeitures allocated to the account after the valuation date but during the valuation calendar year (Treas. Reg. §1.401(a)(9)-5 Q&A 3(b)), and decreased by distributions made during this same period (Treas. Reg. §1.401(a)(9)-5 Q&A 3(a)). Note that if 12/31 is the last day of the valuation year, as it always will be in the case of an IRA, it will be the valuation date, and hence, no adjustment is required.

[12]Based upon the value of the accrued benefit as of the last valuation during the year prior to the year in which you turn age 70½.

[13]Based upon the adjusted value at the end of the year in which you turned age 70½.

[18] The Roth MRD rules do apply to your beneficiaries after death, but the distributions are still income tax free.

[19] A “Designated Beneficiary” is a human being, or a trust, all of the beneficiaries of which are human beings, and which otherwise qualifies under the rules.

[20] The term “Designated Beneficiary” is a term of art, and it means a human being. If there is more than one beneficiary, then all of them must be human beings, or there is no Designated Beneficiary. (This is the Multiple Beneficiary Rule.) There is an exception to the Multiple Beneficiary Rule if each beneficiary has his or her or their own certain separate account. In theory, if the beneficiary is a trust, and all of the beneficiaries of the trust are human beings, they will be treated as Designated Beneficiaries, under the “Look-Through Rule,” if certain conditions are met.

[21] If there is more than one beneficiary, distributions are made over the life expectancy of the oldest, unless the separate account rule applies. (However, in theory, if the regulations are read literally, it will be a rare case when the separate account rule does not apply.)

[22] Under the 5-Year Rule, the entire account balance must be distributed by the end of the 5^th year following the year of death. Distributions before then are optional.

[23] To achieve better estate tax consequences, the spouse could be given the right to disclaim any interest necessary to fully fund a credit shelter or bypass trust, but that is a subject beyond the scope of a nutshell overview.

[24] This table is not relevant until the participant has died.

[25] See generally, Treas. Reg. §1.401(a)(9)-3.

[26]Remember the RBD is April 1 of the calendar year following the calendar year you turn 70½.

[33]Rev. Rul. 2000-2. See also PLRs 9320015, 9317025, 9038015 and 8728011, and see Treas. Reg. §20.2056(e)-2(b)(1)(ii).

[34]Boggs v. Boggs, 117 S.Ct. 1754, 138 L.Ed.2d 45, 65 U.S. L.W. 4418 (1997).

[35]Even in the case of a spouse, rollover may only be an option if the plan offers your spouse an alternative to installment or annuity distributions.

[36]IRC §§402(c)(9), 403(b)(8)(B) and 408(d)(3)(C).

[37]It may be possible for your beneficiary to take the distribution in the form of a nontransferable commercial annuity in this event, but even if this option is available, it is a “second best” alternative. Alternatively, your benefit could theoretically be “transferred” by the qualified plan trustee to another qualified plan, but unless you control the plan sponsor, don’t count on this option.

[38] How many hours are reasonable for an attorney to expend in order to all of these things for you, should you employ an attorney for this purpose? Five hours? Ten hours? At the high hourly rates that most tax lawyers charge, preparing an attorney designed beneficiary designation is liable to be expensive. On the other hand, doing it yourself is risky.

[39] This, of course, guarantees that the benefits will be taxable in the beneficiary’s estate under IRC §2041 for estate tax purposes. If you want your IRA to serve as a bypass trust, I suggest that very careful planning and analysis is called for first. It would certainly be my last choice to perform that function.

ARTICLE 1 Overview and Terminology

ARTICLE 2 EFFECTIVE DATE OF THE Final REGULATIONS

ARTICLE 3 DISTRIBUTIONS DURING LIFE