New 2003 IRA rules make distribution planning easier

by Melissa Klein

The start of the new year means the beginning of another tax season -- and this year, it also means easier distribution planning for advisors with clients who have IRA assets.

The new required minimum distribution rules, which took effect on Jan. 1, have simplified distribution planning in many ways. Here’s a rundown on some of the major changes.

For the first time in 15 years, the Internal Revenue Service has changed the life expectancy tables that IRA owners and beneficiaries use to compute required minimum distributions. While the change is minor - only about an additional year - the required distributions and the resulting income tax will still be slightly lower, which means that most people will pay less tax.

Most IRA owners will use the Uniform Lifetime Table, which assumes a 10-year spread in life expectancy for all beneficiaries, to compute the required minimum distributions, explained David W. Polstra, PFS, CFP, CIMA, of Polstra & Dardaman, Norcross, Ga.

The exception is an IRA owner with a spouse who is the sole IRA beneficiary and who is more than 10 years younger than the account owner. In that case, the owner uses the Joint Life Table, which relies on the actual joint life expectancy of the owner and the spouse and allows for a lower required payout.

The Single Life Table is used by the designated beneficiaries after an owner’s death to compute the minimum distribution for inherited IRA accounts.

The new rules also simplify trustee-to-trustee transfers or transfers from a qualified plan to an IRA after age 70 by eliminating a provision in the proposed rules that required that the transferring custodian pay out the minimum distribution at the time of the transfer to the participant. Under the final rules, the participant is responsible for both calculating and taking out the proper minimum distribution, Polstra noted.

New provisions pertaining to the death of an IRA owner have also been added. "There are three key terms that people need to know when the IRA owner dies," Polstra said.

1. Designation date - defined as Sept. 30 of the year following the year of an IRA owner’s death.

2. Shakeout period - the time period between the IRA owner’s death and the designation date. The shakeout period can be as long as one year and nine months, or as short as nine months and one day.

3. Payment date - the date the first payment must be made from the IRA in order to avoid the 50 percent penalty tax, defined as Dec. 31 of the year following the year of the IRA owner’s death.

"It’s important to cash out any non-human beneficiaries [such as charities] or to separate the accounts before the designation date," said Polstra. "For purposes of calculating the required minimum distribution, the IRS always wants to look at the life expectancy of the Ôworst’ beneficiary. Non-human beneficiaries are the Ôworst beneficiaries.’"

That’s because when a non-human beneficiary is involved, if the IRA owner dies before the required beginning date - April 1 of the year following the year that the IRA owner attains age 70 and the accounts haven’t been segregated by the designation date - the IRS treats the IRA as if there is no designated beneficiary and the five-year payout rule applies for 100 percent of the IRA. That means the IRA must be totally paid out by Dec. 31 of the fifth year following the IRA owner’s death.

However, if the accounts are segregated by the designation date, each beneficiary’s life expectancy can stand on its own when computing the required minimum distribution.

If the IRA owner dies after the required beginning date and has named a charity as the beneficiary, then in the year of the owner’s death, the minimum distribution is based on the Uniform Lifetime Table at the owner’s age on his birthday in the year of his death. For succeeding years, the distributions can be calculated using the single life expectancy in year of death and reducing it by one each year thereafter.

"So if the owner dies post-required beginning date, and a charity or trust that doesn’t qualify as an individual is named as a beneficiary, there is still some salvageable stretch out over the single life expectancy," said Polstra. "The key is to make sure that the accounts are separated no later than the designation date."

"The rules say to segregate the accounts before the designation date, but I tell all of my clients to segregate the accounts in the calendar year of the owner’s death if at all possible," he added.

He gives this example to illustrate the reason for doing so: If 50 percent of the IRA is to be paid to the owner’s 65-year-old sister and 50 percent is to be paid to his five-year-old grandchild, and the owner died in 2002, before his required beginning date, there would be no required distribution in 2002. If the accounts are segregated in 2003 by Sept. 30, the minimum distribution for 2003 to both the sister and the grandchild is made based on the 65-year-old sister’s life expectancy.

The beneficiary life expectancies don’t stand on their own for distribution purposes until 2004. But if the accounts were segregated in 2002, the 2003 minimum distributions would be based on each life expectancy.

Polstra noted another quirk in the new regs. Take the example of an IRA owner who died in June 2002. During the shakeout period, the primary IRA beneficiary - his 65-year-old sister - dies and the secondary beneficiary is the owner’s 35-year-old child.

"Common sense says you don’t have a primary beneficiary because the primary beneficiary died, so the distributions would be based on the life expectancy of the secondary beneficiary, but the IRS says no," said Polstra. "The IRS says you must use the life expectancy of the deceased primary beneficiary for the entire payout period. It remains unanswered whether or not the executor of the 65-year-old sister could disclaim in favor of the 35-year-old child."