Window available for change in beneficiary designation.

Often, individuals who are already receiving payments from their retirement plans and individual retirement accounts (IRAs) may wish to change their designated beneficiaries. Although this is permissible, it could negatively affect the calculation of the individual's required minimum distributions (RMDs). The impact depends on the life expectancy of the new designated beneficiary.

Example: Individual X, now age 72, has an IRA on which he designated his spouse as the beneficiary. X begins taking annual distributions at age 70 1/2, based on his and his wife's joint life expectancy. After two years of payouts, X decides to restructure his estate plan, and change his designated beneficiary.

If the participant changes the designated beneficiary to substitute his child (who has a longer life expectancy than his spouse) after the required beginning date (April 1 of the year after age 70 1/2 is attained), Prop. Regs. Sec. 1.401 (a) (9)-1, Q&A E-5, requires him to continue using the life expectancy of the old designated beneficiary for purposes of determining the distribution period, even though that person is no longer a plan beneficiary. As a result, there is no ability to reduce payouts by designating a younger beneficiary once payments have begun. If the participant change the designated beneficiary to someone with a shorter life expectancy, the same regulation requires the participant to begin calculating RMDs using the new beneficiary's life expectancy. This would accelerate the RMD, which usually is not a desired result. Finally, the participant names a nonindividual as the designated beneficiary, he will be treated as not having designated a beneficiary for purposes of calculating the RMD.

There is an exception to this rule in the proposed regulations, highlighted in Letter Ruling 9704029. Under Prop. Regs. Sec. 1.401 (a) (9)-1, Q&A D-5, the beneficiary of a trust is treated as the participant's designated plan beneficiary for purposes of determining the distribution period under Sec. 401 (a) (9) (A) (ii), if all of the following requirements are met: 1. The trust is a valid trust under state law, or would be but for the fact there is no corpus. 2. The trust is irrevocable. 3. The beneficiaries of the trust, who are beneficiaries with respect to the trust's interests in the employee's benefit, are identifiable from the trust instrument. 4. A copy of the trust instrument is provided to the plan.

In Letter Ruling 9704029, a taxpayer receiving payments attempted to substitute an irrevocable qualified terminable interest property (QTIP) trust for his spouse as a designated beneficiary. Although the facts of the ruling are not complete, it appears that the QTIP trust was created after the participant's required beginning date and after payouts had begun from the IRA. The trust met all four requirements and was nominally funded and intended to receive the IRA benefits as its sole asset. The taxpayer requested a ruling that (among other things) there would be no change in the RMD. In ruling favorably, the IRS stated that the participant, during his lifetime, will continue be able to make withdrawals from the IRA over the joint file expectancy of himself and his spouse -- and the survivor of them -- recalculated annually as necessary to satisfy the minimum distribution requirement of Sec. 401(a)(9). Although the Service did not explain further, it appears as though the IRS viewed this as a substitution of the spouse as designated beneficiary with the spouse via the trust. Thus, for purposes of calculating the RMD, it was no change at all.

This ruling should have interest for estate planners because estate plans are constantly in a state of flux. Clients change their minds regularly as to how they would like their assets distributed and beneficiaries have changes in status (including marriages, divorces and health problems). Often, there is a desire to change the designated beneficiary of an IRA, but the tax consequences may be too great to do so. In the case of a surviving spouse, clients often change their minds as to whether they want their spouses to receive the assets outright or in trust. This ruling, provides estate planners with some flexibility in designating IRA beneficiaries and presumably would allow a taxpayer to change his mind as to whether the designated beneficiary should be the spouse or a QTIP for the benefit of the spouse; the changes could be made either way without affecting the RMD.

It is also important to note that the ruling highlighted the fact that the QTIP trust provided that the trustees were required to withdraw from the IRA and distribute to the spouse on an annual basis the greater of (1) all income earned in the IRA or (2) the amount necessary to satisfy the minimum distribution requirements of Sec. 401(a)(9). Estate planners drafting QTIPS and designating them as beneficiaries of IRA assets need to be mindful of the IRS's position on this point. Thus, the standard QTIP trust document will require some modification to accommodate IRA benefits.

From Maura P. Flynn, CPA, MT, Cohen & Company, Mentop, Ohio