Tax & Business Insights

 IRAs & RMDs - Visiting Byzantium

Volume 13 Issue 2 --  March/April 2001

Individual Retirement Accounts (IRAs) are a common retirement savings method for many.  Even those who participate in other types of retirement plans, like 401(k) plans, may end up with most of their retirement savings rolled over into an IRA, after retirement.

Because contributions to traditional IRAs are tax deductible,  Congress wanted to insure that the tax-free accumulation in IRAs is used for the retirement of the account holder.  As a result, Congress created the idea of the required minimum distribution (RMD) in IRC  401(a)(9).

In 1987, the IRS proposed regulations to implement this concept that were Byzantine in their complexity.  The proposed regulations, while never formally adopted, served as the "law" on this subject for 14 years.

Assuming the citizens of ancient Byzantium could return and read the proposed IRS 1987 Regulations without getting deathly ill, they would probably ask two questions:  (1) why does it take 14 years to get regulations adopted, and (2) why are we considered Byzantine when you have laws like this?

Apart from their complexity, the 1987 proposed regulations had a number of drawbacks.  They required very complex calculations to determine how much had to be withdrawn from an IRA each year.  Even more seriously, they required that a number of extremely important planning decisions had to be made before the IRA owner reached age 70 1/2.  Once made, the decisions could not be changed after that date.

One of the typical planning approaches to dealing with IRAs, particularly large IRAs, is to try to stretch out the payment as long as possible, ideally over several generations. While this could be done under the 1987 regulations, it was difficult and fraught with complexity.

To the surprise of many, the IRS dramatically changed course and, early this year, proposed a new set of regulations that are not only simpler but also allow greater planning flexibility.  Of course, the term "simpler" in this context is relative and should not be taken to mean "easy to read." For a more detailed discussion of the new proposed regulations, click here.

Like their predecessors, they are only "proposed" regulations, but they can be relied upon today.

The three key aspects of the new regulations are:

1. Simpler and lower RMDs

Not only do the new rules simplify the method of determining the annual amount that must be distributed from the IRA (the "RMD"), but in most instances they permit a smaller distribution without incurring penalties.  Of course, if the funds are needed now, then the objective of receiving smaller RMDs over a longer period becomes irrelevant.

2. Greater planning flexibility

Gone is the requirement that all essential planning decisions had to be made by age 70 1/2.  Now, for example, beneficiary designations can be changed up to the date of death and, in some instances, after death. For IRA owners who have reached age 70 1/2, the new rules permit them to change their plans or to make plans if they previously failed to do so.

3. Simpler computation of the RMD

In the past, determining the actual RMD was difficult and frequently done wrongly.  The new rules greatly simplify the actual process of computing the RMD.  The price for this, however, is the new rules require reporting of the RMD to the IRS.  Previously, the IRS had no easy way to know whether the IRA owner actually took the RMD.  Under the new rules, IRA custodians and trustees will have to report this figure to the IRS, although the actual mechanisms for doing this are still in the formulation stage.

The new regulations have not significantly changed the rules according special options to a surviving spouse or the rules relating to trusts and estates as designated beneficiaries. Many of the planning alternatives that existed under the old rules (click here for a detailed discussion of planning under the earlier rules), such as using separate accounts and specially drafted IRA trusts, remain available.  In fact, with the greater flexibility of the new rules, these approaches afford even greater opportunities for planning and we will explore some of these approaches in our next issue.

Copyright 2001
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