A New Advantage for IRA Owners
by Lynn Baxley Ault
Wonderful news has come from the Department of the Treasury! On January 11, 2001, new proposed Treasury Regulations were issued that greatly simplify the calculation of the required minimum distributions which must be taken by the owner of an IRA, as well as by most participants in qualified plans described in Section 401(a) of the Internal Revenue Code.
Not only are these proposed rules a great relief to those who have agonized over the decisions that had to be made about whether the participant should recalculate the life expectancy of herself and/or her spouse for purposes of establishing distribution amounts, but also the new rules allow much greater flexibility in the designation of a beneficiary for a person’s IRA or other employee benefit, removing many of the headaches in planning for the disposition of those assets, and overcoming a major impediment to the naming of a charity as beneficiary.
The prior rules, which have been in place since 1987, were also called “proposed” regulations, but they have been followed as the only guidance available. The 1987 rules forced IRA owners and participants to designate a beneficiary by the required beginning date (April 1 of the year following the year in which the individual reaches age 70 ½ in most cases), and this designation determined the required minimum distribution that must be taken each year until the account was exhausted. Although the “designated beneficiary” could be changed after the required beginning date under the 1987 rules, the minimum distribution that an IRA owner must take could not be reduced. Since a charity had no life expectancy, any IRA owner who named a charity as beneficiary on the required beginning date did so knowing that only one life expectancy, that of the IRA owner, could be used to calculate the required minimum distributions, thus forcing those individuals who named a charity to deplete their retirement accounts much faster than if another individual had been named as a beneficiary. Additionally, if a charity were beneficiary of a part of the IRA and the owner died, the entire account had to be distributed within five years, thus precluding any individual beneficiaries from stretching the IRA distributions out over life expectancy.
Now all this is changed. A uniform table of required minimum distributions will apply to almost all owners of retirement accounts. This table is based on each such account owner’s life expectancy and the life expectancy of a person ten years younger. In other words, the owner will be deemed to have designated as a beneficiary a person 10 years younger than himself for purposes of the calculation. Under the uniform table, the distribution period for a person aged 70 is deemed to be 26.2 years no matter what person or entity the owner may have designated as his or her beneficiary. Thus the amount that would need to be distributed would be the total account balance at the end of the preceding year divided by 26.2.
The rules which have favored the surviving spouse as the sole designated beneficiary continue to do so. The surviving spouse, if the sole beneficiary, is allowed to treat an IRA inherited from the deceased owner by the surviving spouse as his or her own IRA, or the surviving spouse may receive the entire IRA account of the deceased spouse and roll it into an IRA established in the surviving spouse’s own name. Other, non-spousal beneficiaries may take distributions over the remaining life expectancy of the owner or the life expectancy of the beneficiary, whichever period is greater.
As for the “designated beneficiary,” the IRA owner can change the beneficiary designation at any time, and the identity of the designated beneficiary will not be firmly established under these new proposed regulations until the end of the year following the year of the IRA owner’s death. This does not mean that a new or different beneficiary may be named after an IRA owner dies, but the new rule allows a beneficiary, such as a charity, if named to receive a part of the account, to be cashed out, leaving any noncharitable beneficiaries the option of using life expectancy to determine distributions. The delay in finally establishing the identity of the designated beneficiary also enhances a primary beneficiary’s option of disclaiming an interest in the account, if that appears desirable, so that the contingent designated beneficiary becomes the actual designated beneficiary.
Why are these new rules so important to charitable entities? First, because the income tax liability hidden within the retirement accounts has always made these assets a desirable gift to charity for someone who has charitable objectives. If a qualified charity receives a retirement account, the charity, because exempt from state and federal income tax, may retain the entire amount without depletion for income taxes. An individual, however, must pay income tax on any distribution from the account at ordinary income tax rates. Second, because under the old rules if a charity were one of several beneficiaries, the presence of the charity as a beneficiary would prevent the individual beneficiaries from extending distributions from the account over their respective life expectancies. Now, under the new proposed regulations, IRA owners can name charitable organizations as beneficiaries of a part of the account. At the death of an owner the charity can be cashed out, and the non-charitable individual beneficiaries will not have to forgo the option of stretching out the period for distributions.
These new rules should be hailed by all IRA owners, as well as charitable institutions, as the best development for the taxpayer in a long time. Although the effective date of the proposed Regulations is January 1, 2002, an IRA owner has the option of using either the new rules or the old rules in 2001. Since the new rules are more advantageous to most individuals, IRA owners should notify the custodian or trustee of their IRAs in writing immediately that they are electing to be controlled by the new proposed Regulations for the year 2001.
Lynn Baxley Ault is a Partner at Lange, Simpson, Robinson & Somerville LLP. Her practice is primarily in the area of estate planning. A version of this article appeared in United Way of Central Alabama’s Senior Living (2001).
