February 2001
New IRS Regulations Make IRAs More Appealing
By
Neil H. Tipograph, CPA
Brand new Internal Revenue Service regulations are providing a windfall to individual retirement account (IRA) owners and their beneficiaries.
The IRS has overhauled the complex required minimum distribution (RMD) rules, providing taxpayers with a number of new benefits. The long-term consequences to the IRA owner and the beneficiaries are substantial.
The RMD rules establish an annual minimum withdrawal schedule that the IRA owner must follow starting at the required beginning date. RMD rules kick in when an IRA owner reaches the required beginning date, which is April 1 of the calendar year following the year in which the IRA owner attains age 70 1/2. These rules also determine the withdrawal schedule applicable to the beneficiaries of the owner’s IRA.
The rules, in currently proposed form, are intended to go into effect on Jan. 1, 2002; however, taxpayers may rely on these rules immediately even if future guidance is more restrictive. Taxpayers who have already withdrawn their 2001 RMD can take corrective action within 60 days of the distribution.
A number of current tax strategies developed for IRA owners must be revisited. For example, many IRA owners have named their children as beneficiaries to obtain the lowest withdrawals under existing tables. The new rules provide a single method of payout regardless of the beneficiary designation, with an exception for a spousal beneficiary more than 10 years younger than the IRA owner. Thus, taxpayers need not name their children as beneficiaries solely to obtain lower payouts.
Likewise, taxpayers who have setup multiple IRA accounts, each having separate non-spousal designated beneficiary, wish to consider rolling over the accounts into a single account with multiple beneficiaries. This IRA “roll-up” strategy will certainly be desirable if the new rules allow an IRA account, with multiple beneficiaries, to be divided into separate accounts up until December 31 of the year following the death of the IRA owner.
Very simply stated, the new rules provide for lower RMD for both the IRA owner and the designated beneficiaries. The lower payout schedules will allow IRA owners and beneficiaries to greatly extend the life of the IRA account. The longer the IRA exists, the greater the opportunity to grow money on a tax-deferred basis. The extension of the IRA, in combination with pending estate tax reform, enhances the IRA as a wealth accumulation and legacy asset.
Taxpayers who do not need to live off their IRAs will do very well under the new rules. Since distributions from traditional IRAs generate taxable income, taxpayers will achieve significant income tax savings using the lower payouts.
The pending regulations—
provide a simple uniform table that all IRA owners can use to determine the RMD during the owner’s lifetime. This table generally provides more generous factors than the existing tables, allowing for substantially lower payouts.
allow the beneficiary to be changed as late as the end of the year following the year of the IRA owner’s death. A postmortem change of beneficiary may occur if the beneficiary disclaims the benefit in favor of another beneficiary, or if a beneficiary is paid out prior to December 31 of the year after the death of the IRA owner. Minimum distributions to any beneficiary remaining at that time are based on the beneficiary’s life expectancy. This rule applies regardless of whether the IRA owner dies before or after his or her required date. Thus, the 5-year default rule applicable to distrbutions resulting from premature death has been changed to the life expectancy rule.
permit the calculation of post-death RMD based on the decedent’s remaining life expectancy at the time of death, where the IRA account did not have a designated beneficiary.
The new rules fix a number of problems existing with the current IRA distribution rules. The weaknesses of the current regime include situations where—
certain IRA owners will outlive their IRA accounts (i.e., the account will be depleted prior to the owner’s death);
certain family members will be unintentionally disinherited from the owner’s IRA (due to not changing beneficiary designations after age 70 1/2);
certain beneficiaries will receive accelerated distributions upon the death of the IRA owner; and
many IRA accounts existing at date of death of the owner will be quickly decimated by the combination of estate and income taxes due at that time.
Case Study
Joe Smart, CPA, attends a pension seminar on IRA required minimum distributions and learns that the rules have been completely overhauled. He quickly downloads the new regulations from the IRS website (www.irs.gov). Joe has a client in his mid-70s who is currently withdrawing minimum distributions from his IRA. The client has determined that his 2001 RMD is $195,000 and withdraws that amount from his IRA during the first week of January 2001. Under the new table, the client is required to withdraw only $135,000 in 2001. Since the client does not need any of his IRA funds for living expenses, the client wants to return the excess distribution to avoid the additional taxable income in 2001.
Fortunately, the existing IRA rules generally provide that an IRA owner may roll any distribution (other than an RMD) over into the same or another IRA account within 60 days of distribution. Since the RMD is only $135,000, the client has until the end of February 2001 to return the $60,000 excess distribution.
As a result of the rollover, the client will save about $24,000 in federal income taxes in 2001.
Neil H. Tipograph is a tax partner at Imowitz Koenig & Co. LLP and chair of the New York State Society of CPAs Partnerships Committee.
