Planning Opportunities Abound with New IRA Rules

On January 11, 2001, the Treasury issued sweeping changes to the IRA required minimum distribution rules. Typically, when Treasury or the IRS promulgate new rules, taxpayers and professional advisors react apprehensively, fearing the worst, but hoping for the best. In this case, the new IRA minimum distribution rules offer hope for much needed simplicity in the area of IRA distribution planning.

The Old Rules

Since 1987, owners of IRAs have been subject to a rather complex set of rules that govern when distributions from IRAs must start (thus ending the tax-deferral privilege for the distributions), and also govern the rate at which the distributions must be made. Under the old rules, distributions were required to begin by April 1st of the year after the year in which the account owner turned 70 1/2. This "April 1st" date is referred to as the Required Beginning Date.

But more significantly, the Required Beginning Date was also the date by which the IRA owner had to make certain irrevocable beneficiary designations that would ultimately affect the rate at which IRA distributions would have to occur. Make proper beneficiary designations, and distributions could be stretched not only over the lives of the IRA owner and his or her spouse, but also over the lives of the IRA owner's beneficiaries.

Make improper beneficiary designations, or rather simply fail to make any beneficiary designations prior to the Required Beginning Date, and the distributions would be forced out much more rapidly over the single life expectancy of the IRA owner. Even worse, at the IRA owner's death, all IRA balances could be forced out as early as December 31st of the year after the owner's death. This rapid distribution schedule, coupled with the IRA owner's heirs' inability to stretch out the tax-deferral period after the death of the IRA owner, made IRA distribution planning very critical as the Required Beginning Date approached.

In fact, depending on elections made, IRA owners could find themselves subject to one of up to seven alternative distribution schedules. As would be expected, operating under such a complex set of rules caused many IRA owners to inadvertently be locked into required minimum distribution schedules that they would not have preferred had proper beneficiary designations been made prior to their Required Beginning Date.

The New Rules

The new rules represent a dramatic simplification of the required minimum distribution rules, but more importantly, offer taxpayers who have passed their Required Beginning Date hope for ameliorating the adverse tax consequences of having made improper distribution elections and/or beneficiary designations. Rather than seven different distribution schedules, under the new rules, almost all IRA owners will take minimum distributions from their IRAs under one uniform schedule. The only exception is a slower and more favorable distribution schedule for IRA owners who have spouses more than 10 years their junior.

Distributions must still begin by the same Required Beginning Date as under the old rules. But the need to make appropriate beneficiary designations by that date in order to maximize the distribution period during the lifetime of the IRA owner has been eliminated. Regardless of whether beneficiaries have been designated or not by the Required Beginning Date, for most all IRA owners, distributions will be made to account owners at the same rate. For most taxpayers, this uniform schedule will slow the rate of required distributions.

This is not to say, however, that beneficiary designations will become unimportant under the new rules. Beneficiary designations will continue to have significance under the new rules in determining what options are available to the account owner's heirs, for example, if the account owner dies before his Required Beginning Date. Under the worst case scenario, an IRA account could be forced to be liquidated in full by the end of the fifth calendar year after the IRA owner's death.

Effective Date

The new rules are mandatory for distributions for calendar years starting on January 1, 2002, but taxpayers who in 2001 are approaching or are beyond their Required Beginning Date can elect to come under the new rules for 2001 distributions. The following is a summary of IRA owners who are immediately affected by the new rules and who should take immediate action to visit with their financial advisors to reevaluate their beneficiary designations and existing required minimum distribution elections.

Immediate Planning Opportunities

  • IRA Owners Beyond Their RBDs. For IRA owners who are already taking required minimum distributions, their 2001 RMDs will likely be reduced by 20% or more under the new rules. To avoid taking greater distributions than required, taxpayers who fit this profile should discuss the new rules with their advisors before they take their RMDs for 2001.
  • IRA Owners on Single Life Expectancy RMDs. For IRA owners who made improper beneficiary designations prior to their RBD and were locked into more accelerated distribution schedules than actually desired, or for account owners who were originally satisfied with their original elections, but would now like to reconsider their elections under the new rules, these IRA owners should visit with their advisors prior to taking 2001 required distributions. The new uniform distribution schedule available under the new rules could significantly reduce their 2001 required minimum distribution.
  • Spousal Trust Named as IRA Beneficiary. The one situation under the new rules that appears to be more restrictive than under the old rules is where an IRA owner names a spousal trust as the beneficiary of the IRA. Certain planning options previously available under the old rules to surviving spouses after the death of the IRA owner are not available going forward under the new rules if a spousal trust, rather than the spouse directly, is the named beneficiary. The new 2001 rules can materially limit the planning options available to the surviving spouse after the death of the IRA owner. IRA owners who have named a spousal trust as the designated beneficiary of their IRAs should immediately consult with their advisors.
  • Heirs of IRAs; IRA Owner's Death in 2000. Since required minimum distributions can be determined under the new rules for 2001 distributions, any beneficiaries of inherited IRAs who inherited their IRAs as a result of a death that occurred in 2000 may have some very favorable distribution options available to them that were not previously available to beneficiaries of certain inherited IRAs under the old rules.

It is strongly recommended that you contact your CPA or other financial advisor about how these new rules may impact your financial planning in the future.

Contributed to AccountingWEB by H. Bradley Whatley
Tax Director, Pannell Kerr Forster of Texas, P.C.

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