Estate Planning Update

April 2, 2001

RE: IRS Simplifies and Liberalizes the Rules on "Minimum Required Distributions"
        From Qualified Plans and IRAS.

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Introduction: IRS Issues New Distribution Rules For Retirement Plans

In January, 2001, the IRS issued new rules that make sweeping changes in how "Minimum Required Distributions" ("MRDs") from retirement accounts are calculated and when beneficiaries are designated. The IRS has also confirmed that participants in qualified plans can take advantage of these new rules. In general, the new rules are a vast improvement over the old rules; increased is the amount of money taxpayers get to shelter and the length of time they can protect it. Gone is the old complicated process for determining how much money a retiree must withdraw from a retirement account, replaced by a new simple chart as described below. These changes potentially affect everyone over age 70½ who is now taking required distributions from an IRA or other retirement plan such as a 401(k), 403(b), and other individual accounts in an employer-sponsored defined contribution plan (such as a profit-sharing plan), as well as individuals who have inherited an IRA or retirement plan from someone else.

Surprisingly, the changes are almost all good; the necessary calculations have become simpler and the new methods produce smaller required distributions for most people. However, as with any major tax change, it will take a while before the IRS has sorted out all the questions. Let’s start with what we know now.

Effect On IRA Owners Now Over 70½

Simplified payout rules mean smaller distributions are possible for most people. As you know, if you are age 70½ or older, you have reached your Required Beginning Date ("RBD"), and you are required to take a distribution from your IRA every year. You probably know how to calculate your 2001 required distribution, using the old rules. You are entitled to switch to the new rules for this year, 2001, if the new rules give you a more favorable result (i.e. a smaller required distribution).

Under the new rules, everyone uses a new "Uniform Table" to calculate his or her required distributions. The uniform table is reproduced at the end of this memo along with an explanation of how to use it. As a general rule, the uniform table is used whether or not the account's designated beneficiary is the account owner's spouse and regardless of the age differential between account owner and designated beneficiary. With the new system, it no longer matters (for purposes of calculating your lifetime distributions) who is named as your beneficiary, with one exception: if your sole beneficiary is your spouse and your spouse is more than ten years younger than you, then you calculate your distributions using the "joint and survivor life expectancy" of you and your spouse. This will produce an even smaller required distribution than the Uniform Table. Now, under the new rules, it does not matter who your beneficiary is on your required beginning date. In addition, you can keep changing your beneficiaries after your RBD and it will not cause your IRA to be paid out faster. Under the prior rules, the minimum annual distribution depended on several complex factors.

For those interested in withdrawing the absolute minimum amount from their retirement plan accounts, the new rules will result in a lower tax bill, a longer-lived tax shelter for the family, and potentially larger payouts for the owner’s beneficiaries. If you want to withdraw the absolute minimum from your IRA, you will have to tell the plan’s trustee or fiduciary to make smaller payments to you from the account.

The rule changes described above do not affect Roth IRAs, because there are no required distributions during life from a Roth IRA.

Effect on Beneficiaries Now Holding Inherited IRAs

The balance remaining in a retirement account such as an IRA after its owner dies must be paid out within a certain period of time. The post-death payout rules have also been simplified and liberalized as follows:

• If the account has a designated beneficiary, the remaining account balance is paid out over the remaining life expectancy of the beneficiary regardless of whether the owner died before or after his required distribution date. In general, a designated beneficiary must be an individual, such as your child, and can’t be an institution or your estate.

• If the account does not have a designated beneficiary, and the account owner dies after his required beginning date, the remaining balance is paid out over the remaining life expectancy of the account owner, determined just before he died.

• If the account does not have a designated beneficiary, and the account owner dies before his required beginning date, the account balance must be paid out within 5 years after the owner's death.

Under the new rules, the designated beneficiary of a retirement account is determined based on beneficiaries designated as of the end of the year (i.e. December 31) following the year of the account owner's death, instead of being locked in soon after the IRA owner turns 70½. This new rule means that people can change their beneficiary whenever they wish up until their death with no repercussions. In many cases there are opportunities for post-mortem estate planning. For example, a beneficiary could disclaim the IRA allowing it to pass to a contingent and perhaps younger beneficiary. Or a co-beneficiary, such as a charity, whose designation would shorten the IRA payout period, can "cash out", leaving the other beneficiaries free to use their life expectancies. Or the IRA could be divided into separate accounts for multiple beneficiaries with different life expectancies. Anyone who has inherited an IRA and there is still money in the plan should review their options immediately.

The new rules make a number of clarifications to the rule allowing a spouse to roll over the decedent's IRA into her own IRA, but it also adds a new condition not found in the old rules. A spouse-beneficiary may elect to treat her entire interest as beneficiary in the decedent's IRA as her own IRA only if the spouse is the sole beneficiary of the IRA and has an unlimited right to withdraw amounts from the IRA. However, this requirement is not satisfied if a trust is named beneficiary of the IRA even if the spouse is sole beneficiary of the trust.

The new rules continue to allow an underlying beneficiary of a trust to be treated as the account owner's designated beneficiary for MRD purposes when the trust is named as the beneficiary of a retirement plan or IRA, if certain requirements are met (e.g., documentation of the underlying beneficiaries of the trust must be provided timely to the plan administrator). For individual accounts under a defined contribution plan or for IRAs, unless the lifetime distribution period for an account owner is measured by the joint life expectancy of the owner and his spouse, the deadline under the new rules for providing the beneficiary documentation is the end of the year following the year of the owner's death. This rule is consistent with the general deadline for determining the owner's designated beneficiary. Because the designated beneficiary during an owner's lifetime is not relevant for determining lifetime MRDs in most cases under the new rules, the burden of lifetime documentation requirements carried in the old rules is significantly reduced.

Improved Estate Planning Choices For Older Individuals

The new rules expand estate planning opportunities for individuals who are approaching or already past age 70½. Here are two examples:

The old rules made it difficult for a person age 70½ or older to leave retirement benefits to charity. Basically, the rules penalized individuals who chose to leave benefits to charity after age 70½ (by forcing them to take larger distributions from the plan during life). The new rules remove this disincentive to leave money to charity. Under the new rules, leaving retirement benefits to charity does not cause accelerated distributions during life.

The new rules also make it easier for older clients to take advantage of the "stretch IRA" concept. The tax rules for many years have permitted the long-term tax-deferred payout of retirement benefits to younger generation beneficiaries (such as grandchildren) after the death of the original IRA owner. However, the old rules made it difficult for individuals over 70½ to achieve that result. Basically, the old rules said that unless you named a younger generation individual as your beneficiary when you turned age 70½ (and at all times thereafter) your heirs could never take advantage of the stretch IRA. The new rules remove this obstacle. Under the new rules, whoever you designate as your beneficiary can enjoy a deferred payout of the IRA over his or her life expectancy, regardless of when you named him or her as your beneficiary. It no longer matters whether you named some other beneficiary back when you turned age 70½.

Steps You Should Take Now in Light of the New Rules

Here are the steps we recommend you take at this time:

• If you are currently taking required distributions from your IRA or other retirement plan, we would recommend not taking your required distribution for 2001 until you have checked out whether the new rules are available to you and provide you a more favorable result.

Recommendation : IRA owners should immediately recalculate how much they will need to withdraw for 2001 under the new rules and compare that figure to the required payout under the old rules. Those who wind up with a smaller MRD under the new rules and want to take smaller withdrawals should reduce their payouts to conform to the new MRD rule.

• The new rules make clear the importance of properly naming primary and contingent IRA beneficiaries, especially given the post-mortem estate planning opportunities discussed above. You should get written confirmation from your custodian or plan administrator reflecting your primary and contingent beneficiary selections to confirm they have been made and documented.

• If you are taking distributions, as beneficiary, from a retirement plan or IRA you inherited from a deceased individual, we recommend not taking your 2001 distribution until you can determine whether the new rules will apply to your 2001 distribution and if so, how.

• If you are past age 70½, and have been constrained in your choice of a beneficiary for your retirement plan because of the restrictions imposed by the old rules, contact us to review your estate plan including your beneficiary choice.

• Finally, if you are younger than age 70½, and you are not taking distributions from any inherited retirement plan, the new rules, for now, have no effect on you; so pass this estate planning update along to an older friend or relative!

Under the new rules, the above Uniform Table may be used by all IRA owners who have reached age 70½ to determine their annual required minimum distributions for 2001 and later years, and the table is generous, as follows:

For each "Distribution Year" (i.e., a year for which a distribution is required), determine:

(A) the account balance as of the preceding calendar year end; and

(B) the participant's age on his or her birthday in the Distribution Year; and

(C) the "applicable divisor" for that age from the above table.

"A" divided by "C" equals the minimum required distribution for the Distribution Year. In the age 71½ Distribution Year, first reduce the "A" number by the amount of any required distribution for the age 70½ year that had not been taken out by the end of that year.

This table does not apply to beneficiaries of a deceased IRA owner; or if the sole beneficiary of the IRA is the participant's spouse who is more than 10 years younger than the participant. This table may not be used for year 2000 distributions taken in 2000 or 2001.

Conclusion

The "catch" for the simplification of the new rules appears to be in the new reporting requirements imposed by the new rules. All required distributions will now be reported to the IRS by the bank, broker, or mutual fund company administering the IRA or retirement plan, with the taxpayer incurring a 50% penalty if the taxpayer does not take the MRD. This amount will be cross-checked by the IRS just as interest and dividend income is.

All in all, the new rules are quite beneficial in terms of providing simplicity and fewer potential pitfalls than the old rules. The new rules also allow those locked into unfavorable distributions to make changes immediately. The new rules will allow you to spread out distributions, reducing the immediate income tax bite, and allow for continued tax-deferred growth. For more information on the new rules, check out the IRS website at www.irs.gov.

Of course, please feel free to call us to discuss any questions you may have about these new rules or your estate planning.