Navigating the maze of the required minimum distribution rules: new proposed regulations on required minimum distributions go a long way toward easing the complexity of prior proposed regulations, but are still appreciably unwieldy.

EXECUTIVE SUMMARY

* The regulations are proposed to be effective for RMDs for calendar years beginning after 2001.

* An exception to use of the MDIB table applies when the account owner's sole beneficiary is a spouse more than 10 years younger than the account owner.

* The RBD depends on whether the account owner is living or deceased.

In January 2001, the IRS proposed regulations (1) on required distributions from retirement plans, such as qualified plans (including defined-contribution and defined-benefit plans), individual retirement plans (e.g., IRAs), Sec. 457 deferred compensation plans, Sec. 403(b) annuity contracts and custodial and retirement income accounts.

The proposed regulations replace proposed regulations issued in 1987. (2) The revised regulations are proposed to be effective for distributions for calendar years beginning after 2001; however, use before 2002 was available in limited circumstances. (3) For 2001 calendar-year distributions, IRA owners were permitted (but not required) to follow the proposed regulations, notwithstanding the terms of IRA documents. (This rule did not apply to distributions required to be made by April 1, 2001 for 2000. (4))

The new rules are a major simplification, but are not easy to follow. This article provides guidance on the proposed regulations' intricacies. (5) Key terms are defined in Exhibit 1 on p. 119.

RBD for RMDs

One of the more confusing aspects of the required minimum distribution (RMD) rules is determining the required beginning date (RBD). Two general rules apply. If the account owner is living, RMDs must generally begin in the year following the year in which the account owner reaches age 70 1/2 (or retires, if later, in some cases). If the account owner is deceased, the RBD for distributions to account beneficiaries varies depending on the beneficiary and certain elections. The proposed regulations address both rules.

Account Owner Living

Generally under Prop. Regs. Sec. 1.401(a)(9)-2, Q&A-2, plan distributions must begin by April 1 of the calendar year following the calendar year in which the (1) account owner turns 70 1/2 or (2) employee retires from employment with the employer maintaining the plan. Regs. Sec. 1.408-8, Q&A-1(b), defines an IRA account owner as an "employee" for purposes of the RMD rules. For a five-percent owner (as defined in Sec. 416(i)(1)(B)(i)), the RBD is April 1 of the calendar year following the calendar year in which he turns 70 1/2. (6) Exhibit 2 on p. 120 applies the age 70 1/2 RBD rules from 1999 through 2006.

Example 1:J was born on May 10, 1929. She reached age 70 1/2 in late 1999. Her RBD was no later than April 1, 2000. Her second RMD had to be made before 2001. She could elect to use the proposed RMD rules for her 2001 distribution or use the prior rules. The proposed rules are mandatory for her 2002 and subsequent-year distributions.

Example 2: L was born on Oct. 9, 1930. He reached age 70 1/2 in early 2001. His RBD is no later than April 1, 2002. The proposed RMD rules may be used for his first distribution; all subsequent RMDs must be made under the proposed rules.

Account Owner Deceased

According to Prop. Regs. Sec. 1.401(a)(9)-3, Q&A-3, for a deceased account owner, the RBD for one or more nonspousal beneficiaries is generally the end of the calendar year following the calendar year of the account owner's death. For a spousal beneficiary, the first RMD must be made by the later of the (1) calendar year following the calendar year of the employee's death or (2) end of the calendar year in which the employee would have attained age 70 1/2. The period over which distributions must be made depends on the circumstances; see the examples and flowcharts below.

Determining RMDs during Account Owner's Life

The RMD is generally the fair market value of the retirement account at the end of the year preceding the distribution, divided by a life expectancy. Under the proposed rules, if the account owner is alive, the divisor is obtained from the table formerly used to calculate the minimum distribution incidental benefit (MDIB table). The MDIB table assumes use of the account owner's and beneficiary's joint life expectancies, when the beneficiary is 10 years younger than the account owner. (7) Thus, during life, most account owners can determine their RMD based on their current age and the prior-year's ending account balance; see Exhibit 3 on p. 121.

Example 3: B's birthday is October 10; he reached age 70 1/2 during 2001. His IRA account balance at Dec. 31, 2000 was $345,000. B's beneficiary is his spouse, who was age 62 in 2001. The 2001 RMD has to be made by April 1, 2002, and, using Exhibit 3, is $13,636 ($345,000/25.3).

An exception to use of the MDIB table applies when the account owner's sole beneficiary is a spouse more than 10 years younger than the account owner. For distributions during the account owner's life, a longer distribution period (measured by the joint owner and last survivor life expectancy) may be used. The table for determining this period is found in IRS Pub. 939, General Rule for Pensions and Annuities, at Table VI, Ordinary Joint and Last Survivor Annuities, Two Lives--Expected Return Multiples. Pub. 939's Table V, Ordinary Life Annuities, One Life--Expected Return Multiples, is used to determine a beneficiary's life expectancy after the account owner's death. (8)

Using the Flowcharts

If adopted, Prop. Regs. Sec. 1.401(a)(9)-0 through -8 and Regs. Secs. 1.403(b)-2 and 1.408-8 would control RMDs. Flowcharts 1-5 analyze these provisions and relate them to one another. However, because only some of the flowcharts will apply to a given situation, they quickly take the user past inapplicable provisions and directly to the pertinent rules. White the flowcharts should lead to the correct answer in any situation, the results should be verified directly from the statutes and proposed regulations.

[ILLUSTRATIONS OMITTED]

Flowchart 1 is the starting point for all scenarios. If the account owner is living, it will state whether there is an RMD and which flowchart (4 or 5) to use in determining the amount. If the account owner is deceased, Flowchart 2 is used. If the account owner died before the RBD, Flowcharts 2 and 3 determine the designated beneficiary (if necessary) and the period over which distributions must be made. Regardless of when the owner died, Flowchart 2 leads to either Flowchart 4 or 5 to determine the RMD.

Flowchart 4 deals with most distributions from defined-contribution plans. Flowchart 5 addresses distributions (usually annuities) from defined-benefit plans and distributions taken in the form of an annuity. The amount of an RMD under Flowchart 4 must be determined each year. In Flowchart 5, there is a one-time determination of whether the annuity is qualified.

Examples

In each of the examples below, the account owner is (or was) an employee; at issue is the RMD for 2002 (or a later year) and the taxpayer will take only RMDs. Each example starts with Flowchart 1.

Example 4: K was age 70 1/2 at the end of 2001. She owns a regular IRA and does not plan to take distributions as an annuity. K's beneficiary is S, her life partner, to whom she is not married. S is 15 years younger than K. K must take her first RMD no later than April 1, 2002 (see Exhibit 2). Flowchart 1 leads to Flowchart 4. The RMD uses Exhibit 3. Because K is not married to S, she cannot use the Pub. 939 tables to determine the divisor. Even though S is 15 years younger than K, the Exhibit 3 table allows only a 10-year difference.

Example 5: F is the 90% owner and chief executive of a closely held corporation. F is age 70 1/2 at the end of 2001. The corporation has a Sec. 401(k) plan. F's beneficiary is his wife, J, who is 57 years old. F does not intend to take plan benefits in the form of an annuity. Because F owns more than five percent of the company, he must take his first RMD no later than April 1, 2002 (see Exhibit 2). Flowchart 1 leads to Flowchart 4. Because F's spouse is his designated beneficiary and she is more than 10 years younger, Pub. 939, Table VI, is used rather than the Exhibit 3 table.

Example 6: H died on April 12, 2001. He had an IRA, but had not retired and had not begun taking distributions. His sole beneficiary is his spouse, X, age 47. She does not have a current need for the IRA funds and would like to postpone distributions for as long as possible. The account does not force a survivor to use the Prop. Regs. Sec. 1.401(a)(9)-3, Q&A-4(c), five-year rule; neither does the state of the couple's residence. Also, H did not elect the five-year rule. The account documents do not allow a change in beneficiary after an employee's death.

Flowchart 1 leads immediately to Flowchart 2. The middle of Flowchart 2 leads to Flowchart 3 to determine the designated beneficiary. Under Flowchart 3, X is the only remaining beneficiary. Flowchart 3 then leads back to the middle of Flowchart 2. In the bottom righthand corner of Flowchart 2, it must be decided whether X wants to elect to treat H's account as her own. Because she is only 47 and has no current need for the funds, she should elect to treat H's account as her own. Thus, she will not have RMDs from the plan until she reaches age 70 1/2.

Example 7: V was receiving distributions from his defined-contribution plan (but not as an annuity) when he died at age 68. Thus, he died before his RBD. His beneficiaries are his three sons, D (age 32), G (age 29) and S (age 26), in equal shares. D and G do not want current distributions from the plan and want to postpone distributions as long as possible. S wants his total share as quickly as possible. The plan does not force a survivor to use the Prop. Regs. Sec. 1.401(a)(9)-3, Q&A-4(c), five-year rule; neither does the state of V's residence. Also, V did not elect the five-year rule. The plan does not allow a change in beneficiary after the employee's death.

Under Prop. Kegs. Sec. 1.401(9)(a)-4, A-4, an employee's designated beneficiary(ies) is (are) determined based on the beneficiary(ies) designated as of the last day of the calendar year following the calendar year of the employee's death. Thus, S's share of the plan could be paid to him by that date and he would not have to take distributions over his life. Flowchart 1 leads to Flowchart 2 to determine the designated beneficiary(les). Assuming the plan provides for acceptable separate accounting of the different beneficiaries' interests in a reasonable and consistent manner, Flowchart 3 allows use of the "separate account" rule of Prop. Regs. Sec. 1.401(9)(a)-8, Q&A-2. The bottom righthand corner of Flowchart 3 leads back to the middle of Flowchart 2, to complete separate analyses for D and G. Flowchart 3 leads to Flowchart 4. The RMD period is the beneficiary's life expectancy; distributions must start by the end of the year following the year of V's death.

Example 8: A died at age 82. Her beneficiary is her estate. She had been taking distributions from her defined benefit retirement plan as an annuity. She retired at age 63 and was guaranteed 20 years of payments. Her life expectancy at her retirement date was 21.6 years. She died after receiving 19 years of payments.

Flowchart 1 leads to Flowchart 2, which leads to Flowchart 4, because A participated in a defined-benefit plan. Flowchart 5 states that the remaining annuity payments meet the RMD rules.

Conclusion

The proposed RMD rules generally are less complex than the previous rules and allow distributions to be made over a longer period. If recipients desire to minimize distributions, the proposed regulations aid that effort. However, the proposed rules are not simple; careful study is required to apply them correctly. This article's examples, exhibits and flowcharts should assist tax advisers in navigating the maze.

Exhibit 1: Definition of key terms for the RMD rules

        Term                 Definition            Cite/Comment

Required minimum        The amount that must   Prop. Regs. Sec.
distribution (RMD)      be distributed from    1.401(a)(9)-1.
                        a retirement plan to
                        avoid penalties in
                        any year.

Required beginning      April 1 of the         Prop. Regs. Sec.
date (RBD)              year following the     1.401(a)(9)-2, A-2;
                        later of the           for a five-percent-
                        calendar year in       or-greater owner (as
                        which the employee     defined in Sec. 416
                        attains age 70 1/2,    (i)(1)(B)(i)), the
                        or the calendar year   RBD is April 1 of
                        in which the           the calendar year
                        employee retires       following the
                        from employment with   calendar year in
                        the employer           which the employee
                        maintaining the        attains age 70 1/2.
                        plan.

Employee                An employee of the     Prop. Regs. Sec.
                        employer maintaining   1.408-8, A-1(b);
                        the plan or an IRA     savings incentive
                        account owner.         match plans for
                                               employees (SIMPLEs)
                                               and simplified
                                               employee plans
                                               (SEPs) plans are
                                               treated as IRAs for
                                               this purpose.

Designated              An individual          Prop. Regs. Sec.
beneficiary             designated as a        1.401(a)(9)-4. In
                        beneficiary under a    certain cases, a
                        retirement plan.       trust beneficiary is
                        However, if a          ignored; Prop. Regs.
                        nonindividual (e.g.,   Sec.1.401(a)(9)-4,
                        estate, trust or       A-5(b).
                        charity) is a
                        beneficiary, the
                        retirement plan does
                        not have a
                        designated
                        beneficiary.

Minimum distribution    Used while the         Prop. Regs. Sec.
incidental benefit      employee/account       1.401(a)(9)-5(d),
(MDIB) table            owner is alive to      A-4.
                        determine the RMD
                        and assumes that the
                        beneficiary is 10
                        years younger than
                        the employee.

Separate-share or       When beneficiaries     Prop. Regs. Sec.
separate-account rule   wish to receive        1.401(a)(9)-8(d),
                        distributions based    A-4 and -9(c), A-3.
                        on their own life
                        expectancy rather
                        than the life
                        expectancy of the
                        oldest of them, the
                        retirement account
                        may be split into
                        individual accounts.
Exhibit 2: RBD age table *

                                                     Birth year (year
                          Year of 70th   Year of     of first RMD; no
Birth year                  birthday    age 70 1/2  later than April 1)

1928
Birthday: Jan. 1-June 30      1998         1998             1999
Birthday: July 1-Dec. 31      1998         1999             2000

1929
Birthday: Jan. 1-June 30      1999         1999             2000
Birthday: July 1-Dec. 31      1999         2000             2001

1930
Birthday: Jan. 1-June 30      2000         2000             2001
Birthday: July 1-Dec. 31      2000         2001             2002

1931
Birthday: Jan. 1-June 30      2001         2001             2002
Birthday: July 1-Dec. 31      2001         2002             2003

1932
Birthday: Jan. 1-June 30      2002         2002             2003
Birthday: July 1-Dec. 31      2002         2003             2004

1933
Birthday: Jan. 1-June 30      2003         2003             2004
Birthday: July 1-Dec. 31      2003         2004             2005

1936
Birthday: Jan. 1-June 30      2004         2004             2005
Birthday: July 1-Dec. 31      2004         2005             2006

* This table applies for RMD RBD determinations when the following
retirement plans are involved: (1) regular IRAs, (2) retirement plans
when the account owner retires before the RBD, (3) retirement plans
when the account owner is a "five-percent owner" and (4) retirement
plans that require distributions to begin for all covered employees
when the employee attains age 70 1/2. Special rules apply to government
and church retirement plans.
Exhibit 3: Lifetime distribution periods--general
rule (Prop. Regs. Sec.
1.401(a)(9)-5, A-4(a)(2))

Employee's age
in the relevant     Distribution
distribution year      period

    70                  26.2
    71                  25.3
    72                  24.4
    73                  23.5
    74                  22.7
    75                  21.8
    76                  20.9
    77                  20.1
    78                  19.2
    79                  18.4
    80                  17.6
    81                  16.8
    82                  16.0
    83                  15.3
    84                  14.5
    85                  13.8
    86                  13.1
    87                  12.4
    88                  11.8
    89                  11.1
    90                  10.5
    91                   9.9
    92                   9.4
    93                   8.8
    94                   8.3
    95                   7.8
    96                   7.3
    97                   6.9
    98                   6.5
    99                   6.1
    100                  5.7
    101                  5.3
    102                  5.0
    103                  4.7
    104                  4.4
    105                  4.1
    106                  3.8
    107                  3.6
    108                  3.3
    109                  3.1
    110                  2.8
    111                  2.6
    112                  2.4
    113                  2.2
    114                  2.0
    115 and older.       1.8

(1) REG-130477-00 and REG-130481-00 (both dated 1/17/01, corrected 2/21/01).

(2) REG-209463-82 (12/30/97), as subsequently amended by Notices 88-38, 1988-1 CB 524, 96-67, 1996-2 CB 235, and 97-75, 1997-2 CB 337.

(3) See Anns. 2001-18, IRB 2001-10, 791, and 2001-82, IRB 2001-32, 123.

(4) See Ann. 2001-18, note 3 supra.

(5) For an explanation of the rules, see, e.g., Gibson and Stanton, "Simplified Minimum Distribution Rules," 32 The Tax Adviser 303 (May 2001).

(6) A qualified plan may provide that the RBD will be April 1 of the year following the year the employee attains age 70 1/2, without regard to later retirement.

(7) The MDIB table is in Prop. Regs. Sec. 1.401(a)(9)-5, A-4. (The same table was contained in the 1987 regulations, at Prop. Kegs. Sec. 1.401(a)(9)-2.)

(8) Due to their length, the tables are not reproduced here, but may also be found in Regs. Sec. 1.72-9.

Richard P. Weber, Ph.D., CPA
Associate Professor of Accounting
Michigan State University
East Lansing, MI

Steven C. Dilley, J.D., Ph.D., CPA
Professor of Accounting
Michigan State university
East Lansing, MI