The new regulations are official, and they are better than ever.  The biggest substantive change is the revised mortality table used to calculate minimum required distributions (MRD).  Now taxpayers who are age 70½ or older can opt for one of three methods for calculating their MRD:

1.      The pre January 11, 2001 methods.

2.      The January 11, 2001 "uniform life expectancy table."

3.      The revised "uniform life expectancy table" issued on April 17, 2002.

The latest revised table projects longer life expectancies.  A longer life expectancy factored into your balance reduces the MRD. Therefore, keeping in mind our maxim "pay taxes later," we recommend that most clients use the updated "uniform life expectancy table."  Remember, you will need to contact your institutions' benefits advisor to inform them of your choice.

The final regulations require immediate action on the part of IRA and retirement plan owners who are past age 70½ and currently taking MRDs.  The finalized regulations will also have an impact on beneficiaries of IRAs and retirement plans.

At first look, the changes in the mortality tables do not seem as dramatic as you might expect for a 20-year mortality table update.  However, the cumulative benefits of the lowered MRD could be substantial.

For example, assume a taxpayer has reached age 70½ and he or she is required to begin taking distributions from his or her retirement plan.  The taxpayer has $1 million in the account with an 8% rate of return.  Since he or she has other sources of income, the taxpayer wants to invoke our mantra "Don't pay taxes now, pay taxes later," and only withdraw the MRD.  If the taxpayer only withdraws the annual MRD during his or her life, the taxpayer will have over $125,000 more in his IRA at age 90 than he or she would have had under the old rules.

To calculate your new MRD, please turn to our updated minimum distribution calculator.  If you are interested in how the new rules impact the MRD for the beneficiary of your IRA or qualified retirement plan, please use the new calculator.  You can also click on a link to the new tables if you want to make the calculation "manually."

Do I Have to Update my Will and Beneficiary Designation of the IRA?

If your estate planning documents were drafted after January, 2001, and your Wills and the beneficiary designations of your retirement plans use Lange's Cascading Beneficiary Designation (see Jim's article, MRDefenses, as appeared in the March 2001 issue of Financial Planning magazine, Copyright 2001 by Thomson Financial Investment Marketing Group), you only need to notify your institution of your request for lowered MRDs per the new life expectancy tables.

For individuals with Wills and beneficiary designations that were prepared before January 11, 2001, you (or more accurately your heirs) will likely benefit from updating your Wills and beneficiary designations consistent with our recommendations in MRDefenses.  Furthermore, having a "preventive financial health check-up" combined with updating your estate planning documents is almost always a good idea.

More Technical Information -- Generally of More Interest to Advisors than Clients

The regulations as proposed last year provided that a designated beneficiary of an IRA was determined as of December 31 of the year following the IRA holder's death.  This was one of the most popular and favorable aspects of the regulations.  For most cases, this allowed beneficiaries to be paid in full, disclaimers to be effected, and accounts to be divided to take advantage of the greatest possible "stretch" based on different beneficiary life expectancies.

The problem with the December 31 date was that if the beneficiary had to take a distribution during that same year, and the determination was not made until December 31, there was no time to make the proper distribution.  In the final regulations, the designated beneficiaries must be determined by September 30 of the year following the year of the IRA owner's death.  This will allow sufficient time for the beneficiary to calculate and take his or her first MRD of the inherited IRA prior to December 31 of the applicable year.

The IRS has also clarified what happens if a designated beneficiary dies between the date of the IRA holder's death and September 30 of the following year.  In that case, the original beneficiary continues to be the measuring life for determining the distribution period, rather than any successor beneficiary.

The regulations also stipulate that if any named beneficiary wishes to disclaim his or her inherited plan benefits, the disclaimer must meet the rules of a qualified disclaimer under Section 2518 of the Internal Revenue Code.  That means that the beneficiary must comply with all state laws regarding a qualified disclaimer that is usually within nine months for the disclaimer to be effective.

The IRS will Continue to Punish IRA Owners Who Do Not Plan

One major disappointment in the final regulations is that the IRS has not mitigated the harsh affect of the designated beneficiary rules when an IRA owner dies without naming a beneficiary on the IRA or retirement plan when there is a beneficiary entitled to the IRA or plan benefits under the Will or by intestate succession.  It is amazing to me that many taxpayers don't bother to have Wills drafted or complete the retirement plan or IRA beneficiary designation.  Remember:  the beneficiary to a retirement account must be named before the account holder's death or the deserving person will be denied the advantages of the beneficiary's minimum distribution rules.  During the period between the IRA owner's death and the beneficiary determination date (now September 30 of the following year), beneficiaries can be eliminated but they cannot be added.  As I have been preaching for over 20 years, it is critical that you name beneficiaries for your IRAs and qualified plans under the administrative rules of the particular plan to take greatest advantage of tax-deferred growth over the life expectancies of your selected beneficiaries.

There is another good reason to ensure that you have named beneficiaries to your IRAs and qualified plans.  The final regulations retain the proposed rule that if you have a designated beneficiary and you die before your required beginning date for taking minimum distributions (generally age 70½),your beneficiary gets to take advantage of the "life expectancy rule" rather than the "five-year rule."  The five-year rule forces distribution (and taxation) of all your IRA or qualified plan benefits by the end of the fifth year following the year of your death.  The "life expectancy rule" allows your beneficiary to take distributions over his or her life expectancy-hence longer tax deferred growth.  Prior to the 2001 proposed regulations, the five-year rule was the default when an IRA owner died before age 70½ .  For beneficiaries already subject to the five-year rule before the 2001 proposed regulation change, the final regulations contain a transition rule that may allow the beneficiaries to switch to the more favorable life expectancy method.

Trust Beneficiaries

IRA owners who have named or wish to name a trust as the designated beneficiary of their IRA or qualified plan, but want to use the life expectancy of the underlying beneficiary of the trust for determining MRDs must provide documentation of the underlying beneficiaries to the trustee or custodian of the IRA or qualified plan by October 31 of the year following the year of the IRA owner's death-not December 31 as was proposed.  Once again, there is a correction period for old trusts that did not qualify because they hadn't met this documentation requirement.

Reporting Requirements

Last year's proposed regulations contained a requirement that IRA trustees and administrators report to the IRS the amount of the MRD from an IRA (according to "TBA" IRS procedures).  Lobbyists from banks and other financial institutions cried bloody murder.  The IRS has backed off on this reporting requirement for the moment.  For 2003, the trustee or administrator must report to the IRA holder (not the IRS) the MRDs.  In 2004, the trustee or administrator must identify, on Form 5498 filed with the IRS each year, each IRA subject to the minimum distribution requirements.  While there is no reporting requirement for minimum distributions to beneficiaries at this time, the IRS maintains that the agency has adequate authority to require such reporting and states that because it has concerns about the level of compliance in this area, it intends to monitor the effect of the new reporting requirements on overall compliance.

Pension Excise Taxes

What happens if you don't take the full amount of your required minimum distribution?  If the amount distributed to a payee under any qualified retirement plan, pension, IRA, or 457 deferred compensation plan is less than the MRD, the payee is subject to an excise tax equal to 50% of the shortfall.  This penalty tax now applies to required distributions from Roth IRAs as well.  Remember, the original owner of the Roth IRA does not have to take minimum distributions, but the beneficiary of a Roth IRA does.  Although the beneficiary will not be taxed on the distribution from the Roth if it is a qualified distribution, the beneficiary will be subject to an excise tax penalty if he or she fails to take the MRD.

Effective Date

The new regulations apply for MRDs for tax year 2003.  For 2002, taxpayers may compute their required distributions using these regulations, the 2001 proposed regulations, or the original regulations proposed in 1987 that were never finalized.  Otherwise, the regulations take effect on January 1, 2003.