New Retirement Plan Withdrawal Rules

Retirement plans, such as 401(k) plans and Individual Retirement Accounts (IRAs), are increasingly becoming a large percentage of individuals’ estates. The Treasury Department recently issued new Proposed Regulations governing the withdrawal of money from these plans. Until the end of this year, taxpayers generally may rely upon either the old rules, or the new ones, which become mandatory for distributions made after this year. Despite some new fiduciary reporting requirements, the new rules are more favorable than the old rules in most respects. This article provides a general overview of the new rules as they apply to regular IRAs, referred to here as “accounts.” It does not address Roth IRAs (which have special tax treatment) or qualified plans (which involve an added layer of complexity due to special ERISA rules).

When Withdrawals Must Begin. An account owner (“participant”) generally cannot make withdrawals penalty-free until the year in which the participant reaches age 59½. In many cases, participants want to minimize or delay distributions as long as possible to reduce or defer taxes and because earnings inside the account grow tax-free. At some point, the participant must start making withdrawals. This is known as the “required beginning date” and is generally April 1 of the year following the year in which the participant reaches age 70½. A 50% excise tax applies to funds that should have been distributed but were not.

Withdrawals During Participant’s Lifetime. The minimum required withdrawal equals the account value at the end of the preceding year divided by a joint life expectancy. Under the old rules, we look at the actuarial tables calculating the joint life expectancy of the participant and any designated beneficiary (discussed below) named as of the required beginning date. Under the new rules, the withdrawal tables generally only assume the joint life expectancy of the participant and a hypothetical person 10 years younger, even if there is no designated beneficiary. There is a limited exception for spouses of greatly different ages, but in any event, spouses no longer need to decide whether to recalculate life expectancies. Each year, the joint life expectancy decreases.

For example, participant (“P”), who is single, has an account worth $253,000 on December 31, 2001. P is age 71 on April 1, 2002. The joint life expectancy under the tables is 25.3 years. P’s required withdrawal is calculated as follows:

Account Balance 12/31/01:	$253,000
Divided by withdrawal factor:	25.3
Required 2002 withdrawal:	$10,000

Each year, the participant goes through this process by dividing the prior year-end account balance by the appropriate life expectancy factor. Using this single set of tables is much simpler than the complicated computation required under the old rules.

Withdrawals After Participant’s Death. When the participant dies, the key factors controlling the amount of required minimum distributions are (1) whether there was a “designated beneficiary” (and, if so, whether it was the participant’s spouse); and (2) whether the participant died before the required beginning date.

Under both the new rules and the old ones, it is important to know whether the participant has a designated beneficiary, although the new rules are far more lenient regarding the timing of the designation. A designated beneficiary must be an individual (e.g., not an estate, charity or trust), but the rules treat some trust beneficiaries as designated beneficiaries. Under the new rules, the identity of the designated beneficiary may be determined as late as December 31 of the year following the participant’s death.

If the participant does not name his or her spouse as the sole designated beneficiary, then the rules are simple:

1. If the participant died before the required beginning date, the account must be paid out over the life expectancy of the designated beneficiary, or, if there was no designated beneficiary, within five years of the participant’s death.
2. Conversely, if the participant died after the required beginning date, the distributions must be made over the life expectancy of the designated beneficiary, or, if there was no designated beneficiary, over the life expectancy the participant had at death.

In any case, however, the distributions must be at a rate at least as fast as the participant’s prior rate of distributions.

If the sole beneficiary is the participant’s surviving spouse, there are two possibilities:

1. The spouse can “roll over” the IRA or elect to treat the IRA as his or her own IRA, designate a new beneficiary, and wait until the surviving spouse’s required beginning date to start withdrawals.
2. The spouse can defer distributions until what would have been the required beginning date of the participant. Special rules deal with spousal only withdrawal rates and the treatment of any funds at the surviving spouse’s death.

Summary. Many questions exist regarding the new rules. They are, however, simpler to administer and have the effect in most cases of prolonging the required distribution period and minimizing the required amount of annual distributions. Participants generally make withdrawals based on a uniform set of tables, and the designated benefi–ciary rules have been greatly relaxed. These new rules will offer significant planning opportunities in certain cases.

Please call one of our estate planning attorneys if you would like further guidance regarding retirement plan withdrawals.