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IRA-designated beneficiary not bound by owner's pre-death withdrawal calculations.

As the U.S. population ages, it is increasingly important for advisers to have a thorough understanding of the minimum required distribution (MRD) rules for retirement plan owners who reach age 70 1/2. The wrong advice can cause plan beneficiaries to incur income tax much sooner after the owner's death than is necessary.

In Letter Ruling 200018057, the IRS ruled that IRA distributions after the death of the IRA owner could be spread over the IRA beneficiary's life expectancy, even though he had calculated his MRDs based only on his single life expectancy. The ruling surprised many advisers, who may have fallen into a common trap and recommended the distribution of the entire IRA balance within one year after the owner's death. (These same rules apply to IRA, Sec. 401(k), pension and other retirement plans.)

MRD Rules

In general, Sec. 401(a)(9) and the related regulations require an IRA owner to begin receiving MRDs no later than the required beginning date (RBD). The RBD is April 1 of the year following the year in which the IRA owner turns 70 1/2.

The MRD for any year is the value of the IRA as of December 31 of the previous year divided by the applicable life expectancy. The applicable life expectancy for a particular year is either (1) the joint life expectancy of the IRA owner and a timely named designated beneficiary (i.e., named before the RBD) or (2) the single life expectancy of the IRA owner, if he does not timely name a designated beneficiary. With either a single or a joint life expectancy, the life expectancy can be calculated by either electing to (1) reduce the IRA owner's or the designated beneficiary's life expectancy, or both, by one each year (i.e., the term-certain method) or (2) recalculate the IRA owner's or the designated beneficiary's life expectancy or both each year (i.e., the recalculation method).

The key to Letter Ruling 200018057 is to understand the "election" rules. Prop. Regs. Sec. 1.401(a)(9)-1, Q&A E-7, provides a specific "election" process for choosing whether to recalculate life expectancies or use the term-certain method. However, in determining whether to use single life or joint life expectancies, the Code and regulations specify that, if a designated beneficiary has been timely named, the MRD calculation automatically uses the joint life expectancy of the IRA owner and the designated beneficiary. Prop. Regs. Sec. 1.401(a)(9)-1, Q&A F-1, does not require any "election" to be made between joint life and single life expectancy

Regardless of which method an IRA owner uses to calculate annual distributions, if he dies after reaching the RBD, any remaining balance in the IRA must be distributed "at least as rapidly" as under the method of distribution being used before his death.

If an IRA owner did not timely name a designated beneficiary (i.e., the MRD was calculated on the owner's single life expectancy) and elected the recalculation method to calculate his life expectancy, at death his life expectancy becomes zero, and the entire balance must be withdrawn by the end of the calendar year following the calendar year of the owner's death.

Letter Ruling 200018057 centered on what happens if an IRA owner did timely name a designated beneficiary, but nevertheless chose to calculate his IRA distributions based on single life expectancy, using the recalculation method?

Letter Ruling 200018057

A father turned 70 1/2 in 1990 and began receiving MRDs from his IRA by the RBD of April 1,1991. He continued taking distributions annually from his IRA until his death in 1998. The father had timely named his daughter as his IRA's designated beneficiary. However, he had not been computing his IRA distributions based on joint life expectancy; instead, he had been determining them based on his single life expectancy, recalculated annually.

The IRS determined that, although the father had been receiving lifetime distributions from his IRA over his single life expectancy (using the recalculation method), he could have been receiving them over the joint life expectancy, because he had timely named his daughter as his designated beneficiary. In effect, the father was simply choosing to receive lifetime distributions in amounts greater than the MRDs. Obviously, nothing prevents an IRA owner from taking distributions that exceed the MRD, whether this is because he simply wants more money or (as in Letter Ruling 200018057) was erroneously calculating what he thought to be the MRD based on his single life expectancy.

Therefore, the Service concluded that, under the "at least as rapidly rule," the daughter was not precluded from receiving IRA distributions after her father's death using only her own life expectancy. This allowed the daughter to receive the benefits of continuous, tax-deferred income growth by "stretching" distributions over her life expectancy.

Conclusion

The IRS's conclusion in Letter Ruling 200018057 merely follows the rules as stated in the Code and regulations, which provide that MRD calculations are based on the joint life expectancy of the IRA owner and the designated beneficiary. However, before this ruling, many taxpayers and their advisers may not have reached the same conclusion as the Service. As such, Letter Ruling 200018057 provides a good lesson on how to avoid the unnecessary loss of income tax-deferred growth in the IRA occurring after an IRA owner's death.

FROM TODD A. GARDNER, CPA, AND MARVIN D. HILLS, CPA, SOUTH BEND, IN

Frank J. O'Connell, Jr., CPA, J.D. Crowe Chizek Oak Brook, IL
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Article Details
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Title Annotation:Letter Ruling
Author:O'Connell, Frank J., Jr.
Publication:The Tax Adviser
Geographic Code:1USA
Date:Sep 1, 2000
Words:918
Previous Article:Research credit and the 1999 Act.
Next Article:Safe-harbor sec. 401(k) Plans.
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