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Retirement Benefits Planning Update
Retirement Benefits Planning Update provides information on developments in the field of retirement benefits law. The editors of Probate & Property welcome information and suggestions from readers.
Final MRD Regulations
The overview chart presents a snapshot of the minimum required distribution (MRD) rules that apply to individual account qualified plans and IRAs under the final regulations published on April 17, 2002. 67 Fed. Reg. 18,988. The final regulations apply to MRDs for calendar years beginning on or after January 1, 2003, but, according to the regulations’ preamble, “taxpayers” may rely on the regulations for 2002 MRDs. IRA owners and beneficiaries may elect to use the new rules for 2002, but plan participants and beneficiaries may receive distributions based on the 2002 rules only if the plan is amended to apply the rules to 2002. Presumably, a plan participant or surviving spouse beneficiary could roll over the excess of the amount of a plan distribution received over the 2002 distribution required to an IRA. The new rules will apply to distributions to all beneficiaries made in 2003 and later years. If the participant died before 2003, the identity of the participant’s designated beneficiary must be re-determined and the applicable distribution period must be reconstructed using the new rules. Treas. Reg. § 1.401(a)(9)-1, Q&A 2. Like the proposed regulations issued on January 17, 2001, 66 Fed. Reg. 3,528, the final regulations further simplify the MRD rules, sometimes to the participant’s advantage and sometimes not. The changes made to the 2001 regulations as they affect participants in qualified individual account plans and the account owners of traditional IRAs (“participants”) are highlighted below.
In response to the mandate of Section 634 of EGTRRA, the final regulations introduce new life expectancy tables that reflect year 2000 mortality factors to determine the applicable distribution periods. The Uniform Lifetime Table that applies to distributions required to be made to participants for the year preceding the participant’s required beginning date (RBD) and continuing through the year of the participant’s death adds just over or just under one year to the annually re-determined distribution periods. Treas. Reg. § 1.401(a)(9)-9, Q&A 2. To simplify the computation of the distribution for the second distribution calendar year (the year in which the RBD occurs), the new regulations change the rule that applies if the initial MRD is made in the second distribution calendar year on or before the RBD. The MRD for the second distribution calendar year is now computed by dividing the account balance at the end of the first distribution calendar (unreduced by the MRD made early in the second year) by the table’s distribution period. Thus, deferring the initial MRD to the year of the RBD not only results in two distributions being included in the participant’s taxable income for the second distribution calendar year but also increases the amount of the second distribution. Compare Prop. Treas. Reg.§ 1.401(a)(9)-5, Q&A 3(c)(2) to Treas. Reg. § 1.401(a)(9)-5, Q&A 3.
Relaxing the rule in the 2001 regulations that, in order for the Joint and Last Survivor Table to apply, the participant and a more-than-10-years-younger spouse who is the participant’s sole designated beneficiary must be married during the entire calendar year, the final regulations permit the joint life table to apply for the year in which either the participant or spouse dies as long as the couple is married on January 1. The joint table also applies in the year of a couple’s divorce but apparently only if no successor beneficiary is designated during that calendar year. Treas. Reg. § 1.401(a)(9)-5, Q&A 4(b)(2).
Under the final regulations, the key to determining the applicable distribution period for MRDs beginning in the year following the year of the participant’s death is the identity of the participant’s oldest designated beneficiary (DB), if any, with respect to the participant’s account or a separate share of that account. The basic definition remains the same: a DB is a beneficiary who is designated as beneficiary under the plan or by the participant’s affirmative election, if the plan so provides. A non-individual may not be a DB and, if the participant’s estate, a charitable organization, or other entity is a DB of the account (or of a separate share), the participant will be treated as having no DB even if there are also individual beneficiaries designated with respect to that account or share. Treas. Reg. § 1.401(a)(9)-4, Q&A 1 and 3. If there are multiple individual DBs, the applicable distribution period is measured by the oldest DB’s life expectancy. Treas. Reg. § 1.401(a)(9)-5, Q&A 7.
The final regulations state that DBs are determined based on the beneficiaries designated as of the date of the participant’s death who remain beneficiaries as of September 30 of the calendar year following the calendar year of the participant’s death (referred to on the chart as the “designation date”). To be a DB, an individual must be a beneficiary as of the date of death as well as on the designation date . Treas. Reg. § 1.401(a)(9)-4, Q&A 4. The designation date was moved up from December 31 of the year following the participant’s death under the 2001 regulations so as to eliminate the administrative catch-22 of having to make the initial post-death distribution on the same day that the DB was to be identified. By introducing the “window period,” the 9-to-21 month period between the participant’s date of death and the designation date under the final regulations, the 2001 regulations made uniform the post-death planning options that could affect the applicable distribution period (the disclaimer by a beneficiary and the creation of separate accounts). These options were previously available only if a participant died before the RBD. The opportunity to cash out a beneficiary’s full benefits before the designation date was also added. The proposed regulations, however, did not describe the consequences of other window period events (the death of a beneficiary or the transfer of benefits by a beneficiary, such as by an estate or trust, to its individual beneficiaries) and did not indicate whether the successors to a disregarded beneficiary’s interest were to be taken into account in determining the applicable distribution period as of the designation date.
Window Period Disclaimers
Window period disclaimers that satisfy Code § 2518 are expressly recognized as removing the disclaiming person from the pool of DBs. Treas. Reg. § 1.401(a)(9)-4, Q&A 4(a). The beneficiaries who receive the participant’s benefit upon disclaimer will presumably be taken into account in determining the applicable distribution period only if it can be said that the successor beneficiaries were designated by the plan or the participant (as would be the case if the successor beneficiaries were named on the participant’s beneficiary designation). If a trust is named as beneficiary, the individual trust beneficiaries (including the individual beneficiaries of any resulting trusts) would, if the trusts qualify for the look-through rules, be considered to be beneficiaries designated by the participant as of the date of death. Individual beneficiaries in favor of whom a disclaimer by the trustees is made should therefore be recognized as beneficiaries on the designation date. The final regulations rephrase the 2001 regulations’ statement that the participant’s estate may not be a DB to provide that the fact that the participant’s plan or IRA interest passes to an individual under a will or otherwise under state law does not make that individual a DB unless the individual is designated as a beneficiary under the plan. Treas. Reg. § 1.401(a)(9)-4, Q&A 1. If a participant designates an estate as beneficiary and designates the individuals who are the beneficiaries of the estate as contingent beneficiaries, it may be that a disclaimer by the participant’s executors would result in the successor individual beneficiaries being considered DBs. Although a beneficiary’s disclaimer or the full payment of a beneficiary’s benefits may eliminate potential DBs, the distribution of the benefits during the window period by an estate named as beneficiary to individuals will not eliminate the estate as a beneficiary. Similarly, as discussed under the separate account rules below, the distribution from an original revocable trust named as beneficiary to resulting marital and bypass trusts will not eliminate the original trust as a beneficiary and the beneficiaries of all of the resulting trusts must be considered as look-through beneficiaries to determine the applicable distribution period for each of the trusts.
Death During the Window Period
It had appeared under the 2001 regulations that, because DBs were defined as individuals living on the designation date, the successor to a deceased beneficiary would be taken into account in determining the applicable distribution period for an account or separate share. This would have caused there to be no DB if the beneficiary’s estate were the successor or caused a longer payout period if younger generation beneficiaries succeeded. The final regulations provide that an individual who is a beneficiary as of the participant’s death and dies before the designation date without disclaiming is treated as if the beneficiary were a DB for purposes of determining the MRD period. The identity of the successor beneficiary who is entitled to receive MRD distributions is disregarded. Treas. Reg. § 1.401(a)(9)-4, Q&A 4(c). Note that the final regulations clarify that the special rules that apply to a spouse who is the participant’s sole DB (box 11 on the chart) only apply to a spouse who survives until the designation date and becomes the participant’s sole DB. Treas. Reg. § 1.401(a)(9)-4 Q&A 4(b). If a spouse who is the sole beneficiary dies before the designation date, distributions must be made in accordance with box 7 (the 5-year rule) or box 8 (over a fixed life expectancy period discussed below) rather than over the re-determined single life expectancy of the spouse.
Applicable Distribution Periods
Minor changes were made to the 2001 regulations’ rules governing the applicable distribution periods that apply following a participant’s post-RBD death and following a sole DB surviving spouse’s death. If a participant who dies after the RBD has a DB (other than a spouse who is sole DB), the payout period is now the greater of (1) the DB’s life expectancy determined based on the age attained in the year after the participant’s death (the only rule under the 2001 regulations) or (2) the participant’s life expectancy based on the age the participant attained (or would have attained) in the year of the participant’s death. Treas. Reg. § 1.401(a)(9)-5, Q&A 5(a) (box 8). Since the second alternative added by the final regulations is the rule that applies if a participant dies after the RBD without a DB (box 4), the new rule eliminates the penalty that applied under the 2001 regulations if the participant named a DB who was one or more years older than the participant. An inconsistency under the 2001 regulations in determining the applicable distribution period that applies after the death of a surviving spouse who is the sole DB (box 11) was fixed in the final regulations, so that the spouse’s fixed life expectancy for the year of death (the life expectancy factor that is the starting point for computing the post-death payout period) is reduced by one beginning in the year following the spouse’s death (rather than in the year after the year following the spouse’s death). Treas. Reg. § 1.401(a)(9)-5, Q&A 5(c)(2).
Separate Account Rules
The final regulations stipulate that actual separate accounts must be established under the plan on a date no later than the end of the year following the year of the participant’s death, with a pro rata allocation of investment results being made from date of death to the date of establishment. Treas. Reg. § 1.401(a)(9)-8, Q&A 1 & 2. It is not clear, however, how the deadline for establishing separate accounts affects the determination of the DB on the three-months-earlier designation date. For example, assume a participant who died after the RBD designates the participant’s spouse (50%), the participant’s son (25%), and a charity (25%). Without separate accounts, the participant’s fixed life expectancy rule (box 4) would apply to all of the benefits because the charity cannot be a DB. If separate accounts are established, the spouse may receive benefits based on the spouse’s redetermined single life expectancy under box 11 and the son may receive distributions over his fixed life expectancy under box 8. Would the distribution for the year following the participant’s death be based on the no DB rule of box 4 if separate accounts are not established until December 31 of the year after the participant’s death and the payments in the following year be based on the DBs of the separate accounts established by year end? The question can be avoided if separate accounts are established before the designation date. The regulations initially state that separate accounts are not recognized until the year after the calendar year in which the separate accounts are established. Would separate accounts have to be established in the year of the participant’s death in order to be recognized on the designation date or does the establishment of accounts by the end of the year following the year of death override this initial rule (as the examples in the regulations imply)?
Separate accounts are not available to the beneficiaries of a trust with respect to the trust’s interest in the participant’s benefit. Treas. Reg. § 1.401(a)(9)-4, Q&A 6(a). This statement serves to underscore the fact that resulting trusts that are created under a single trust agreement as of a participant’s death (such as marital and bypass trusts under a revocable trust, separate children’s trusts, or generation-skipping transfer tax-exempt and non-exempt trusts) are treated as beneficiaries of the original trust and, unless the resulting trusts are separately named in the beneficiary designation itself, all of the beneficiaries of all of the trusts are taken into account under the look-through rules in determining the applicable distribution period for each separate trust. Treas. Reg. § 1.401(a)(9)-4, Q&A 6(d).
Beneficiaries of Beneficiaries
The 2001 regulations affirmed PLR 199935052 by expressly stating that a beneficiary may designate a successor beneficiary to receive distributions of any portion of the participant’s benefit after the beneficiary’s death. Prop. Treas. Reg. § 1.401(a)(9)-5, Q&A 7(d). Although the final regulations deleted this section of the 2001 regulations, it does not appear that the deletion was intended to change the rule because reference to the beneficiary of a deceased beneficiary is made in the final regulations’ provision regarding the death of a beneficiary during the window period, stating that such a successor beneficiary will be disregarded in determining the participant’s DB. Although the identity of the successor beneficiary of a beneficiary who dies during the window period will not affect the applicable distribution period, in many cases the beneficiary’s probate estate (the default successor under most IRAs) may not be the optimal choice if probate avoidance is a goal.
To avoid the fixed life expectancy payout that will occur if a surviving spouse sole beneficiary of a participant dies during the window period (whether the participant dies before or after the RBD), a spousal rollover or own account election (box 12) should generally be planned to occur immediately after the participant’s death. The final regulations clarify that, if a spouse elects to make an IRA account the spouse’s own account in the year of the participant’s death, an MRD (otherwise required to be made from the spouse’s IRA in the year of the election if the spouse has passed the RBD) will not be required if an MRD already must be made from the IRA for that year based on the participant’s life expectancy. Treas. Reg. § 1.408–8, Q&A 5. A spouse who is under age 59 1 / 2 may wish to defer a rollover to keep the account (or part of the account) as the participant’s account so that the spouse, as beneficiary, can withdraw funds without a 10% penalty on premature distributions. In such a case, if the participant has died before the RBD, the spouse should designate successor beneficiaries on or before the designation date because, if the spouse dies after becoming a DB and before the required commencement date (the end of the calendar year in which the deceased participant would have attained age 70 1 / 2 had the participant survived), the five-year rule will apply if the spouse has not named a DB.
Depending on what future guidance the IRS may issue, the final regulation provisions appear to represent a retrenchment on the part of the IRS, returning to the simplistic approach of applying the rules for individual beneficiaries to the complex succession of beneficial interests that modern trusts are designed to accomplish. Except in the case of a conduit trust (in which the trustees are required to distribute all plan and IRA benefits received to a trust beneficiary who is then recognized as the sole look-through beneficiary of the trust), the final regulations appear to require that all trust beneficiaries, including even remote remainder beneficiaries, be taken into account as DBs. If the trustees have the power to accumulate plan and IRA benefits in trust and a successor beneficiary has any “right (including a contingent right)” to receive the accumulated benefits, the successor may not be disregarded in determining the oldest look-through DB or whether there is a look-through DB. Treas. Reg. § 1.401(a)(9)-5, Q&A 7(c). In an example of a QTIP trust (Trust P) benefiting a participant’s spouse with the participant’s children as the sole remainder beneficiaries, payments are permitted to be made over the spouse’s fixed single life expectancy and no mention is made of cleanup beneficiaries (“No other person has a beneficial interest in Trust P”). Does this example merely beg the question of whether remote remainder beneficiaries (for example, the beneficiaries of the children’s estates if the children predecease their mother) are required to be taken into account? Or does the example imply that some remote beneficiaries may be disregarded? Treas. Reg. § 1.401(a)(9)-5, Q&A 7(c)(3), Ex. 1.
The preamble to the regulations states that a Code § 645 election by a trust to be treated as an estate for income tax purposes will not cause a trust to be treated as an estate for MRD purposes. The final regulations do not address the question of whether a trust provision that permits the trustees to pay a participant’s estate tax (either in general or to the extent attributable to plan and IRA benefits) causes the participant’s estate to be deemed a trust beneficiary nor whether a trust provision that permits the use of plan or IRA benefits to pay estate tax (but only during the window period) will avoid the potential problem. Finally, the copy of the trust agreement or a list of beneficiaries (and their entitlements) must be delivered to the plan administrator on or before October 31 of the year following the participant’s death instead of on or before December 31 of that year as provided in the 2001 regulations. Treas. Reg. § 1.409(a)(9)-1, Q&A 2(c).
The task of reconstructing the applicable distribution periods that currently apply to plan and IRA beneficiaries of participants who died in years before 2002 in order to determine MRDs for 2003 and future years will test the scope of the guidance given in the final regulations. Distributions measured by a single DB’s life expectancy will be reduced. A beneficiary whose applicable distribution period was determined under the 1987 rules based on the fixed joint life expectancy of a participant and beneficiary will be measured by a single fixed life expectancy and, even under the new tables, distributions will increase. Only two transition rules are provided. A trust named as beneficiary may cure the technical defect in the look-through rules’ compliance of having not delivered a trust agreement (or beneficiary list) to the plan administrator by acting on or before October 31, 2003. Treas. Reg. § 1.401(a)(9)-1, Q&A 2(c). No one, however, could have predicted the interpretation of the look-through rules that the final regulations adopt based on the language of the 1987 regulations that describes which contingent beneficiaries may be disregarded. If the reconstruction results in non-individual remote remainder beneficiaries of a trust being taken into account, a single sum distribution (either in 2003 or before the end of the fifth calendar year after the participant’s death) may have to be made to the trust if the participant died before the RBD or, if the participant died after the RBD, distributions will have to be made over the balance of the participant’s fixed life expectancy. Under the second transition rule, a DB who was subject to the five-year rule under the 1987 regulations but did not begin to receive distributions before the end of the year following the participant’s death under the exception to the five-year rule may switch to the life expectancy rule if a plan permits, provided that all amounts that would have been required to be distributed under an application of the life expectancy rule are distributed by the earlier of December 31, 2003, or the end of the five-year rule period. Treas. Reg. § 1.401(a)(9)-1, Q&A 2(b)(2).
Retirement Benefits Planning Update Editor: Harvey B. Wallace II, Joslyn Keydel & Wallace, LLP, Albert Kahn Building, 9th Floor, 7430 Second Ave., Detroit, MI 48202–2717, email@example.com.