March 2001

New Required Minimum
Distribution Rules

by Ted Rice

On January 17, 2001, the IRS released new proposed regulations1 that simplify the calculation of required minimum distributions ("RMDs") from employer-sponsored qualified retirement plans, 403(b) plans, and individual retirement accounts ("IRAs"). These proposed regulations, as authorized under Internal Revenue Code ¤ 401(a)(9), mandate when and how RMDs must be made to participants and their beneficiaries. The Internal Revenue Code requires distributions from affected plans to be made at a designated point in time because of the tax-deferral benefits participants and their beneficiaries receive under these plans.

A major criticism of the old RMD rules, issued as proposed regulations by the IRS in 1987 and never finalized, was the sheer complexity of the required determinations and calculations. While certain complexities remain in the new rules, they will clearly be easier to administer and will benefit participants and their beneficiaries.

This article focuses on the RMD determinations applicable to RMDs paid from defined contribution qualified retirement plans ("qualified plans") and IRAs. Qualified plans are tax-exempt entities under I.R.C. ¤ 401(a) and include 401(k), profit sharing, stock bonus, and money purchase pension plans. IRAs affected by the new RMD rules include traditional, SIMPLE and SEP IRAs (and Roth IRAs with respect to beneficiary RMDs). "Participants" as used in this article means both qualified plan participants and IRA owners unless otherwise specified.

With respect to qualified plans, the new RMD rules are proposed to be effective for distributions for calendar years beginning on and after January 1, 2002. Qualified plan sponsors may rely on the old proposed regulations until the new RMD rules become final regulations. However, qualified plan sponsors may adopt a plan amendment to make the new RMD rules effective for calendar year distributions beginning on or after January 1, 2001. The IRS provided a model amendment for this purpose in the preamble to the 2001 proposed regulations.2

For IRAs, the new RMD rules are also proposed to be effective for 2002. However, for calendar year 2001 RMDs (and until final regulations are published), the IRS allows IRA participants and beneficiaries to follow either the new or old RMD rules. IRA plan documents should not be amended to include the new RMD rules until after the IRS publishes final regulations.3

Required Beginning Date ("RBD").
To apply the RMD rules, the required beginning date ("RBD") must be determined for the affected participant. For qualified plan distributions generally, the RBD is the April 1 following the later of the year age 70 ½ is attained (the "70 ½ year") or the year of retirement. However, if the affected participant is an owner of 5 percent or more of the qualified plan sponsor, his or her RBD is the April 1 following the 70 ½ year. For IRAs, the RBD is the April 1 following the 70 ½ year. Note that for Roth IRAs there is no RBD for the participants, as RMDs must only be made to the beneficiaries following the participant's death. Although a participant's RBD is the applicable April 1 date, each subsequent year's RMD must be made by December 31 of the RMD year.

The 70 ½ year is determined in the same way as under the old RMD rules. If a participant attains age 70 between January 1 and June 30 during a year, the participant's 70 ½ year will be that year. If a participant attains age 70 between July 1 and December 31 during a year, the participant's 70 ½ year will be the next year.

Basic RMD Calculation The basic calculation for all RMDs is to divide the participant's account balance by the applicable life expectancy multiple. The applicable life expectancy multiple will now be determined for most participants from the uniform table identified in the new RMD rules, though certain situations still require use of the other single and joint life expectancy tables used under the old RMD rules. The participant's account balance for RMD calculation purposes is the account balance as of the last valuation date of the plan year-end immediately preceding the year for which the RMD will be made (plus applicable contributions and forfeitures allocated as of that date). For example, for a calendar year plan, the applicable account balance required for a participant's 2002 RMDcalculation is the last valuation date of the 2001 plan year, December 31, 2001.

Distributions Before Death As of the participant's RBD, the participant must begin taking distributions at least as rapidly as determined under the new RMD rules. The participant's life expectancy for this purpose is his or her life expectancy multiple determined from the uniform table included in the new RMD rules.4 The uniform table uses the joint life expectancy of the participant and a beneficiary who is ten years younger than the participant.

However, if the participant's spouse is the sole designated beneficiary and more than ten years younger than the participant, a longer joint life expectancy multiple can be used. The new RMD rules allow for the use of the longer life expectancy multiple as determined from 1) the uniform table using the participant's age, recalculated annually, and 2) the joint life expectancy multiple from the joint life expectancy tables using both the participant's and spouse beneficiary's age, recalculated annually. In almost every instance, the joint life expectancy multiple will be longer than the life expectancy multiple determined under the uniform table, and resulting RMDs will be smaller.

Using the uniform table is a considerable simplification over the prior rules because it eliminates many of the issues created by determining the applicable life expectancy multiples for participants and beneficiaries. Another simplification is that all life expectancy determinations for participants under the uniform table are recalculated from year to year thus eliminating the old requirement to designate the method of calculation ("recalculate" or "reduce by one"). "Recalculate" means that the applicable life expectancy multiple is determined each year. "Reduce-by-one" means that the applicable life expectancy multiple is determined in the first year, then simply reduced-by-one for each subsequent year. The reduce-by-one method continues to be used, but only upon the death of a participant where a non-spouse beneficiary is designated or upon the death of a spouse beneficiary who was receiving RMDs. In these events, the reduce-by-one method is required for continuing RMDs and therefore no election to use it or another method is necessary.

For both qualified plans and IRAs, the new RMD rules cannot be applied to a year 2000 RMD, even if it is the participant's first RMD and paid by April 1, 2001. Also note that qualified plan RMDs must be made by each qualified plan under which a participant has a plan balance, while IRA RMDs may be made from each IRA or aggregated together by the participant and made from only one of the participant's IRAs. Finally, special rules must be reviewed for situations involving rollovers, transfers, or qualified domestic relations orders.

Ted Rice is senior corporate counsel with U.S. Bancorp in Minneapolis. He is a 1983 graduate of Hamline University School of Law and has practiced employee benefits law for 18 years.

"Special rules apply where multiple beneficiaries have been designated"

Determination of Beneficiary Because the uniform table will be used to determine RMDs to participants, determining beneficiaries for RMD purposes and using the single and joint life expectancy tables will be important only for the following situations: 1) before the participant's death if the participant's spouse is the sole designated beneficiary and is more than ten years younger than the participant (as noted above), and 2) after the participant's death to determine after-death RMDs.

For after-death RMD purposes the participant's designated beneficiary is determined by December 31 of the year after the year the participant dies. This extended period allows for disclaimers, distributions, and other events to leave a beneficiary planned (or at least designated) by the participant to receive distributions under a favorable payout schedule (meaning a lesser annual RMD). Of course planning for such events will be most relevant for those participants with large qualified plan or IRA balances.

The new RMD rules continue to allow for a trust to be the designated beneficiary and for the life expectancies of the trust beneficiaries to be used in determining RMDs, as long as all such beneficiaries are individuals and are identifiable. A spouse beneficiary of a trust may take advantage of the special rules for spouse beneficiaries, but only if he or she is the sole beneficiary under the trust. The deadline to provide the applicable documentation of the trust to the plan's administrator and trust beneficiaries under the new RMD rules is revised to be the end of the year following the year of the participant's death. The new RMD rules also clarify that a testamentary trust qualifies as a trust that may be considered in determining beneficiaries.

Special rules apply where multiple beneficiaries have been designated. If the beneficiaries' allocable amounts of the participant's plan account are divided into separate accounts, then the new RMD rules are applied to each beneficiary with respect to his or her life expectancy. Generally, if separate accounts for the beneficiaries are not established, then the age of the oldest beneficiary is used to determine the applicable life expectancy and resulting RMDs. When there is a non-individual beneficiary (other than a "look-through" trust acknowledged under the new RMD rules), the IRS deems that no beneficiary will have been designated and the participant's plan account must be completely distributed by the end of the fifth year following the participant's death.

Death Before RBD
When a participant dies before his or her RBD, the RMD options depend on who is determined to be the designated beneficiary. If the designated beneficiary is the participant's spouse, the spouse must begin RMD distributions by the later of the end of the year following the year of the participant's death or the end of the year the participant would have attained age 70 ½. When the applicable life expectancy RMDs begin, the spouse's single life expectancy is determined and recalculated each year in accordance with the same single life expectancy tables applicable under the old RMD rules. Alternatively, the spouse beneficiary may roll over the plan account to his or her own IRA. This will result in the RMD rules being applied to the spouse as the participant.

If the designated beneficiary is a non-spouse, the deadline to begin RMDs depends on whether the beneficiary wishes to take life expectancy distributions or receive a lump sum from the plan. If the beneficiary wishes to begin life expectancy payments based on the beneficiary's life expectancy (determined from the beneficiary's birthday during the year of the participant's death), these distributions must begin by the December 31 of the year following the year of the participant's death. The beneficiary's life expectancy is reduced-by-one for each year following the first year. Otherwise, the beneficiary may wish to take a lump sum or a series of distributions from the plan and do so by December 31 of the year that is five years after the year of the participant's death (the "five-year rule").

In a change from the old RMD rules, the new rules deem the life expectancy method to be the default method for non-spouse beneficiaries who do not elect a method of payment. The old RMD rules deemed the default method in this situation to be the five-year rule. Under the new RMD rules, however, if a beneficiary who is the sole beneficiary does not take life expectancy payments but receives a complete distribution from the plan under the five-year rule, a waiver of the otherwise applicable 50 percent excise penalty tax will apply. The 50 percent excise penalty tax, under I.R.C. ¤ 4974, applies against RMD amounts for a particular year that are not received by a participant or beneficiary; (such amounts are referred to as "excess accumulations").

Death After RBD
The RMD calculations applicable for a designated beneficiary of a participant who dies after the participant's RBD depend on whether the designated beneficiary is a spouse or a non-spouse. If the participant's spouse is the sole designated beneficiary, then RMDs continue in the year following the death of the participant based on the spouse's single life expectancy, recalculated each year until the spouse's death. Upon the spouse's death, one or more beneficiaries designated by the spouse may continue to receive RMDs from the qualified plan or IRA. These RMDs are made using the spouse's life expectancy determined in the year of the spouse's death, then reduced-by-one each year following the spouse's death.

For a non-spouse beneficiary or if the participant's spouse was not the sole beneficiary, life expectancy payments can continue using the beneficiary's single life expectancy determined in the year of the participant's death and reduced-by-one each year thereafter until the account is fully paid out. Obviously, the younger the beneficiary, the longer the beneficiary's life expectancy will be and the longer in terms of years RMDs will be paid.

The new RMD rules are more favorable to plan sponsors and participants than the old rules and may be utilized for calendar year 2001 RMDs in the manner authorized by the new RMD rules. The new proposed regulations may be relied upon until they are finalized and no change to the RMD rules included in the final regulations that would not be as favorable as the rules included in the new proposed regulations will be given retroactive effect. Remember that for both qualified plans and IRAs, the new RMD rules cannot be used for year 2000 RMDs, even if these RMDs are a participant's first RMD and delayed until April 1, 2001.

Qualified plan sponsors should consult their qualified plan advisors to determine if the new RMD rules should be available for use by affected participants and beneficiaries for 2001 calendar year RMDs. If it is determined that the new RMD rules should be adopted for 2001 calendar year RMDs, the IRS model amendment must be adopted for such plans.

IRA plan sponsors are not required to make IRA amendments that incorporate the new RMD rules until the IRS finalizes these rules and publishes further guidance. However, no IRA plan amendment is necessary for IRA participants and beneficiaries to begin to use the new RMD rules for calendar year 2001 RMDs.5

Anyone either receiving or about to receive RMDs from a qualified plan or IRA should consider consulting with a qualified tax attorney, accountant, or estate planner. The advisor can review how the new RMD rules affect the individual and help determine whether any change should be made to beneficiary designations.

Because the new RMD rules are in the form of proposed regulations, the IRS will consider comments it receives and finalize the regulations at some point. Anyone interested in following the progress of these new proposed regulations should monitor employee benefits update services, such as http://www.newRMD.com and http://www.benefitslink.com, or consult with a tax attorney, accountant or estate planner about the status of the new RMD rules.

1. The new proposed regulations are cited as Proposed Treasury Regulations ¤ 1.401(a)(9)-0 through ¤ 1.401(a)(9)-8; ¤ 1.403(b)-2; ¤ 1.408-8; and ¤ 54.4974-2. You can find the new RMD rules on the Internet at http://www.benefitslink.com/taxregs/rmd2001.shtml. This version of the new proposed regulations reflects the new RMD rules with technical corrections included (as issued by the IRS in February 2001in IRS Announcement 2001-18) (66 F.R. 3928). See IRS Announcement 2001-23 issued on March 5, 2001, for an IRS summary of the new RMD rules.
2. IRS Model Amendment:

With respect to distributions under the Plan made for calendar years beginning on or after January 1, 2001 (ALTERNATIVELY, SPECIFY A LATER CALENDAR YEAR FOR WHICH THE AMENDMENT IS TO BE INITIALLY EFFECTIVE), the Plan will apply the minimum distribution requirements of section 401(a)(9) of the Internal Revenue Code in accordance with the regulations under section 401(a)(9) that were proposed on January 17, 2001, notwithstanding any provision of the Plan to the contrary. This amendment shall continue in effect until the end of the last calendar year beginning before the effective date of the final regulations under section 401(a)(9) or such other date as may be specified in guidance published by the Internal Revenue Service.

The adoption of this amendment must meet the formal, authorized plan amendment process required under the qualified plan, including, as applicable, the adoption of a corporate board resolution authorizing the amendment.
3. <I>Written comments about the new RMD rules are due to the IRS by April 19, 2001, and a public hearing on the new RMD rules has been scheduled for June 1, 2001. The IRS has asserted that the Bush Administration's moratorium on the issuance of new regulations does not apply; therefore the new RMD rules may be relied upon as specified by the IRS.
4. The uniform table that is used to identify the applicable life expectancy factor for most participants under the new RMD rules can be found at http://www.benefitslink.com/taxregs/rmd2001.shtml. The other single and joint life expectancy tables required under the new RMD rules are included in IRS publication 590 (Individual Retirement Arrangements) http://www.irs.gov/forms_pubs/pubs.html.
5. IRA plan sponsors must also be aware of the new RMD rules proposal that IRA sponsors send annual reports to the IRS and affected IRA participants and beneficiaries. These reports would identify applicable RMDs for IRAs serviced by the IRA sponsor. Should this proposal be included in final regulations, IRA sponsors will need to address administrative and operational issues raised by this reporting proposal.