The new set of proposed regulations for minimum required distributions (MRDs), issued in January by the Internal Revenue Service, has dramatically simplified the process of withdrawing assets from IRAs and retirement plans. The biggest advantage is that in nearly all cases, payouts can be stretched out longer than under the previous rules.
Although still technically proposals, the rules can be used for 2001 required distributions, and then become mandatory beginning next year.
“The old method mixed together so many factors; it was too confusing,” says David Rankin, a broker at First Union Securities in Philadelphia.
Gone are the term-certain, recalculation and hybrid methods and the need to choose among them. Almost all individuals (owners and their heirs) will use one IRS table to calculate MRDs.
“A lot of planning was complicated and restrictive because once you were locked in to your choices, you were locked in for life,” says Steve Shagrin, a rep with Salomon Smith Barney's Youngstown, Ohio, office. “Now we don't have to run five or six cases of what-ifs. We look at standard tables and plug in the information. It certainly simplifies the process by one or two steps.”
And the new procedures will save clients money. “[The IRS] is allowing everyone the opportunity to stretch out the distributions after they pass away,” Rankin says.
In fact, an IRA may never have to be fully depleted. For a 70-year-old, the IRS table shows a life expectancy (withdrawal factor) of 26.2 years. Dividing a $100,000 account by 26.2 gives you the required first-year distribution — roughly $3,800, or 3.8%. The next year, the withdrawal factor would be 26.2 minus one, or 25.3, which would require about a 4% distribution assuming the account remains at $100,000. Even conservative investment returns should be able to maintain a considerable part of the account or even grow it.
(Note that calculations in real cases are not always this simple. Expert tax counsel is still required.)
But what's clear is that, for most people, distributions can be minimized much more than in the past. “Our clients are thrilled,” says Dodee Frost Crockett, a rep with Merrill Lynch in Dallas. “We take out the mandatory amount and let the rest work for them.”
Clients already taking distributions under the old calculations can switch to the new, more favorable rules.
Why has the IRS made this friendly gesture? Congress was about to mandate simplification, for one thing. But the IRS also hopes to make it easier to police compliance. Prior to the change, financial services providers found it difficult to offer customers every distribution option without making mistakes. And mistakes are costly — clients still face a 50% penalty if they withdraw too little.
Focus on Beneficiaries
Most of the planning issues with the new rules revolve around beneficiaries. Make sure clients have named them.
“For whatever reason, people spend very little, if any, time thinking about their beneficiaries,” says Mary Beth Cavey, an IRA marketing manager at First Union Securities in Richmond, Va. “If they're married, they name the spouse. If the individual is widowed or single, then it's the children or the estate that's named. In some cases, that's not maximizing their options.”
Clients have always benefited from naming beneficiaries on their beneficiary forms (naming the estate is still not smart). It remains the case that if you die prior to your required beginning date (RBD) and have not named a beneficiary, the five-year distribution rule applies — assets must be paid out within five years. If you die after MRDs begin, and you have no beneficiary, whoever inherits the IRA takes distributions based on the life expectancy of the owner at death.
So it still pays to be current on beneficiary designations.
And under the new rules, clients still have to name beneficiaries prior to death. However, the designated beneficiary is not finalized until Dec. 31 of the year after the plan participant dies.
The old rules could severely penalize IRA beneficiaries if IRA owners had made poor distribution choices as of their RBDs — April 1 of the year after turning 70½. Once done, those choices were locked in.
“The key now is to focus on beneficiary planning by making sure the primary and secondary beneficiaries are named and that everything is in place,” says Ed Slott, an IRA expert and CPA in Rockville Centre, N.Y. Financial advisers can get somewhat creative with beneficiaries to keep the money growing as long as possible, Slott says.
How? With the time window now available, older beneficiaries can be cashed out, disclaim the assets or be given separate accounts after the owner's death, thereby minimizing payouts. So, it's especially important now to name contingent beneficiaries in order to maximize these planning opportunities, Slott says.
Here are the basic strategies tax experts suggest:
“Bad” beneficiaries can disclaim assets: Where there are multiple beneficiaries, distributions are calculated based on the life expectancy of the oldest individual. But an older beneficiary can disclaim benefits and pass them to a younger beneficiary (younger siblings, a child or grandchild) who was also named by the IRA owner prior to death. The younger person can then use his or her long life expectancy to minimize distributions.
In an article written for the April issue of the Journal of Financial Planning, attorney Natalie Choate, with Boston-based law firm Bingham Dana, says that under the old rules, it was not clear whether disclaimers were effective in shifting benefits for MRD purposes. The IRS now acknowledges that disclaimers work for MRD purposes.
Experts warn, though, that in order for a disclaimer to work, the person disclaiming the inheritance cannot retain any interest in the property (a spouse being the one exception) and cannot direct where property goes.
“Bad” beneficiaries can be cashed out: Choate notes that another way to rearrange the beneficiaries is to pay out the entire share of the plan owed to older beneficiaries and/or institutions like charities. If a nonindividual beneficiary is one of multiple beneficiaries, the life-expectancy payout method can't be used. Cashing out these nonindividuals, as well as the older heirs, leaves just the younger, individual beneficiaries. In the past, cash-outs had to be done by the date of death or the RBD, whichever came first, making charitable bequests tricky.
Set up separate accounts for multiple beneficiaries: This option existed already, but now it can be done post-death, up to Dec. 31 of the year after the year the owner passes away. If beneficiaries are given separate accounts (they are still IRAs in the owner's name), they can each use their own life expectancies to take distributions and to control the investment decisions in those accounts. Experts urge being clear on IRA beneficiary forms as to who gets what share.
Choate also writes in her article that this technique may not work if the owner had begun distributions. So check with tax advisers.
Simple, But …
Even under the simplified rules, MRD calculations can still be messed up. MRDs can vary based on a number of factors, including whether the owner had begun distributions or whether the IRA was inherited from the spouse of the owner. The five-year rule still applies in some cases depending on when the owner died and who the beneficiary is. These are just a few of the wrinkles.
“I encourage clients to have their tax adviser call us or we'll call them,” Crockett says.
Amazingly, brokers say some tax advisers don't appear to be focusing on the new withdrawal schedules. “We've already had a few people call to say that their [tax] adviser hasn't mentioned any of this,” Crockett says.
While the new rules eliminate the pressing need to make MRD elections at age 70½, reps say clients still want to hear about the impact of the changes. This interest should not come as a surprise.
“Virtually everyone in the past 20 years has taken on 401(k)s or IRAs,” Rankin says. “And every one of these individuals will be directly affected by the new regulations.”
Registered Representative welcomes your comments on this story. Contact Editor in Chief Dan Jamieson at [email protected] or call 800/621-0720.
Go to www.rrmag.com for live links to these resources:
The March and April issues of the Journal of Financial Planning have detailed articles by attorney Natalie Choate of Boston-based Bingham Dana. Part I is at www.journalfp.net/fpajournal/jfp0301-art10.cfm. Part II is at www.journalfp.net/fpajournal/jfp0401-art11.cfm. Choate also has her own site at www.ataxplan.com.
Roth IRA Advisor site, by Jim Lange, a CPA and attorney in Pittsburgh, at www.rothira-advisor.com/index.htm. Lange includes the IRS' uniform withdrawal factor table at www.rothira-advisor.com/mrd_table.htm.
IRA Tax Center, by Ed Slott, CPA, in Rockville Centre, N.Y., at www.irahelp.com.
Internal Revenue Service page explaining MRDs and the new rules at www.irs.ustreas.gov/prod/bus_info/ep/rmd_faq1.html.