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KEYWORD:
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Employee Benefits Bulletin, May 2002Final RMD Regulations Published Different from the 2001 Proposed Regulations?The tax-deferred contributions and growth permitted in qualified retirement plans are a great benefit to participants and significantly increase the amount that may be collected for retirement in a company's plan. In fact, the decision to forgo immediate taxation on retirement plan contributions and earnings is one of the largest expenditures of the federal government. However, all good things must come to an end-since the tax-deferral is designed only to encourage savings for retirement, the government will not allow the tax-deferral in a retirement plan to extend indefinitely. Participants are forced to withdraw some of their savings (and, consequently, pay tax on those amounts) each year when they reach retirement age. The law governing the amount and timing of these withdrawals may be found in the required minimum distribution ("RMD") rules of Internal Revenue Code §401(a)(9). Specifically, the RMD rules require participants with benefits in qualified retirement plans, 403(b) plans and 457 plans (other than 5% owners) to begin taking distributions at the later of age 70 1/2 or termination of employment. IRA owners must begin taking RMDs at age 70 1/2 even if they are still employed. The Internal Revenue Service ("IRS") designs regulations to implement these rules and published final regulations on RMDs in the Federal Register on April 17, 2002 ("Final Regulations"). The Final Regulations supercede the proposed regulations issued in January 2001 and affect tax-qualified retirement plans, 403(b) annuity contracts, certain 457 plans, and Individual Retirement Accounts ("IRAs"). To understand the importance of the new Final Regulations, the background of these regulations must be discussed. The IRS originally issued proposed regulations on RMDs in 1987. These regulations were extremely complicated and confusing to participants and plan administrators alike. The 1987 proposed regulations served as the governing guidance for RMDs until January of 2001, when the IRS overhauled its RMD rules and issued a new set of proposed regulations. Even though the 2001 proposed regulations are much simpler than the 1987 rules, a comprehensive explanation of the way they work is beyond the scope of this article. In a nutshell, the proposed regulations set up a methodology for RMDs of participants and their beneficiaries based upon three life expectancy tables. Depending on the circumstance, the participant or beneficiary will divide their account balance in a defined contribution retirement plan or IRA by the number corresponding to their age on one of the life expectancy charts. This division produces the RMD for the year. In the following year, the RMD recipient will divide the remaining account balance by the divisor previously used less one. (More complicated rules exist for defined benefit pension plans and 403(b) annuity contracts. Normally, actuaries calculate the RMDs in these plans.) The 2002 Final Regulations retain the much celebrated, simplified framework of the 2001 Proposed Regulations and add new elements, including (but not limited to) the following: (1) New Life Expectancy Tables. Section 634 of the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") required the IRS to modify its life expectancy tables to reflect current data. The Final Regulations adopt three revised life expectancy tables based on mortality information from the year 2000. The life expectancy since 1983 (year upon which the tables were previously based) has increased, resulting in larger divisors on the tables and smaller RMDs in most cases. (2) New Deadline for Determining a Designated Beneficiary. The 2001 proposed rules permit a "designated beneficiary" to be determined as late as the end of the year following the year of the participant's (or IRA owner's) death. The first RMD from the inherited benefit to the beneficiary must also be made on December 31st of the year following the year of the participant's death. Many commentators pointed out that the timing in the 2001 proposed regulations would cause hardships on administrators trying to calculate and distribute the initial RMD by the year-end deadline, since, in some cases, beneficiaries wait until the last minute to finalize paperwork. The Final Regulations advance the deadline for determining a designated beneficiary from December 31 to September 30 of the year after a plan participant's year of death, making it easier to determine the initial distribution that must be made by the end of that year. (Please note that new beneficiaries cannot be added after a participant's death. A change in designated beneficiary after the participant's death may only occur through disclaimer or total payout of a beneficiary's portion.) Additionally, the deadline for providing documentation for identification of trust beneficiaries has been moved up from December 31st to October 31st of the year following the year of the participant's death. (3) Clarification of Separate Account Rules. Under the 2001 proposed rules, if the participant names multiple beneficiaries before his or her death, RMDs must be based on the age of the oldest beneficiary. The Final Regulations clarify that if the inherited benefit is split into separate accounts by the end of the year following the year of the participant's death, then each beneficiary can use his own life expectancy to compute RMDs. If the life expectancy of the oldest beneficiary is used to calculate RMDs on all accounts, the inherited benefit may be split into separate accounts at any time. (4) Calculation Simplification. The Final Regulations also simplify the calculation of RMDs by eliminating certain variables that might change during the year. For example, the Final Regulations provide that for RMD payments during a participant's life, a participant's marital status is determined on January 1 of each year. Thus, divorce and death are not taken into account until the year after they occur. Additionally, contributions and distributions made after December 31 are disregarded for purposes of determining the RMD for the following year. Another simplification-death of a beneficiary before the September 30th "designation date" does not remove that person as a designated beneficiary. (5) IRA Trustee Reporting Requirements (Notice 2002-27). Notice 2002-27 requires IRA trustees to report the 2003 RMD amount to IRA owners, or to calculate it for the owners on request. It is important to note that IRA trustees are not required to report to the IRS in 2003. However, beginning in 2004, trustees must also identify to the IRS each IRA in which an RMD is required for the year (but the amount of the RMD is not required to be reported). The IRS also made significant changes to a section of the regulations dealing with annuity payments and defined benefit pension plans. In order to allow the public an opportunity to comment on the changes in Reg. § 1.401(a)(9)-6T, it has been issued as temporary and proposed regulations instead of part of the Final Regulations. The Final Regulations are effective for distributions for calendar years beginning on or after January 1, 2003. For distributions during calendar year 2002, plans may utilize the Final Regulations or, depending upon plan language, the 2001 or 1987 proposed regulations. (Some plans have already been amended to utilize the 2001 proposed regulations.) According to the preamble of the Final Regulations, the IRS will release guidance on amending qualified plans to conform to the new changes. For a copy of the new Final Regulations and preamble as they appear in the Federal Register, go to http://www.benefitslink.com/taxregs/rmd2002final.pdf.
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