IRS Proposes Revised 
IRA Distribution Rules and 
Other Recent Changes

February 2001 Update

On January 17, 2001, the IRS published in 66 Federal Register 3928 (January 17, 2001) a new set of proposed rules, Prop. Regs. § 1.401(a)(9)-1 et seq., relating to IRA distributions that substantially simplify and modify a number of the rules discussed in the article “Income Tax and Estate Planning for Large IRAs.”  In particular, the proposed new rules significantly alter, among other components:

• the rules for computing the minimum required distributions from the IRA

• the rules relating to the designation of beneficiaries

• the rules governing the consequences of beneficiary designation on the minimum distribution requirements.

The net effect of these changes is not only to simplify the process of complying with the IRA rules but also to allow greater flexibility in planning and using IRAs.

From a planning perspective, one of the most significant effects of the new proposed rules is the change in the time at which the designated beneficiary is determined.  As “Income Tax and Estate Planning for Large IRAs” explained, under the prior rules, if the beneficiary was not designated by the date at which distributions are required to begin (soon after age 70½), the options for IRA distributions were greatly reduced.  Similarly, it was not possible to change the beneficiary after that date.

Under the newly proposed rules, however, the designated beneficiary is determined as of the end of the year following the death of the IRA owner.  Therefore, beneficiary designations can be changed up to the date of death, because the designation of the beneficiary no longer affects the computation of the minimum required distribution.  Moreover, certain post-death events, such as disclaimers, will now be taken into account in determining who is the designated beneficiary.

In a nutshell, the new distribution rules, subject to a number of exceptions and qualifications, are as follows:

1.                  Distributions must begin as of the required beginning date (same as under the old rules), but the minimum distribution is determined based on the IRA owner’s life expectancy under a uniform table. 

2.                  If the IRA owner dies before beginning distributions (i.e., the required beginning date), there are two basic alternatives:  

-         If there is a designated beneficiary, over the life expectancy of the beneficiary;

-         If there is no designated beneficiary, over a five-year period.

3.                  If the IRA owner dies after beginning distributions (i.e., the required beginning date), there are two basic alternatives: 

-         If there is a designated beneficiary, over the life expectancy of the beneficiary;

-         If there is no designated beneficiary, over the remaining life expectancy of the IRA owner immediately before his or her death.

Thus, even where the IRA owner dies without a designated beneficiary, in many instances the value of the IRA can be distributed over a period of years (determined by the IRA owner’s life expectancy immediately prior to death), rather than all in the year after death, as the old rules required.

The new rules would also bear upon a number of other planning issues.  They clarify certain questions about designating trusts as beneficiaries, although they retain the same basic approach as the earlier rules.  Similarly, while keeping some of the provisions of the old rules on the rights of a surviving spouse to treat the IRA as his or her own, the new rules do make several important clarifications and modifications. Under the new rules, it now appears that if a trust is a beneficiary, even if the surviving spouse is the sole beneficiary, this may prevent the spouse from making this election.

The new rules also mark several important procedural changes in the rules.  Now, for the first time, IRA trustees and custodians will be required to report to the IRS the amount of the minimum distribution requirement.   

Officially, the IRS says the new proposed regulations will be effective beginning January 1, 2002.  IRA owners and beneficiaries, however, may elect to apply the new rules in year 2001 for purposes of computing required distributions or they may continue to apply the old rules.

November 2006

The Pension Protection Act of 2006 made two significant changes in the distribution rules applicable to IRAs. First, the prior right of a spousal beneficiary to roll-over an inherited IRA into the spouse's own IRA has now been extended to other beneficiaries. In other words, after January 1, 2007, a non-spouse beneficiary who inherits an IRA now has the option to roll the distribution over into the beneficiary's own IRA rather than being forced to take or continue receiving distributions as required for the deceased owner's IRA. In order to take advantage of this rule, the assets must be transferred from the original IRA to the seconds IRA in a trustee-to-trustee transfer. 

Second, the 2006 Act also authorized up to $100,000 in tax-free withdrawals from IRS for payments to certain charities for individuals who are at least 70 and 1/2 years old. This rule applies in 2006 and 2007. The mew in effect allows an IRA owner to exclude from income up to $100,000 in both 2006 and 2007 if the IRA funds are contributed directly to one of the so-called 50% charities -- i.e., charities that qualify for the 50% of AGI deduction limit. The amounts distributed to charity count toward satisfying the minimum distribution requirements for the year.