Understanding the Minimum Distribution Rules

Transcription

1 MinDistRules 2013.wpd 8/5/11 4/5/13 Understanding the Minimum Distribution Rules The Estate Planner s and Financial Advisor s Guide to the Defined Contribution Plan Minimum Distribution Rules By: Natalie B. Choate, Esq. Nutter McClennen & Fish LLP Boston, MA. This Seminar Outline contains an expanded version of Chapter 1of Natalie Choate s book Life and th Death Planning for Retirement Benefits (7 ed., 2011; Ataxplan Publications), which may be purchased for $89.95 plus shipping by calling , or at Copyright 2011 by Natalie B. Choate; all rights reserved. Summary Table of Contents Abbreviations and symbols used in this Outline Introduction to the MRD Rules MRD Fundamentals MRDs During Participant s Life The RBD and First Distribution Year MRDs after the Participant s Death Special Rules for the Surviving Spouse The Beneficiary and the Designated Beneficiary Modifying MRD Results after Participant s Death Enforcement of the MRD Rules...77 Appendix A: Tables...80 Appendix B: Other Excerpts from the Book...83 Appendix C: Resources...88

2 2 Detailed Table of Contents Abbreviations and Symbols used in this Outline Introduction to the MRD Rules Where to find the law Which defined contribution plans are subject to the MRD rules MRD economics: The value of deferral WRERA suspended minimum distributions for Ten planning ideas (good and bad) for MRDs MRD Fundamentals The 12 Fundamental Laws of the MRD Universe Which distributions count towards the MRD IRS tables for determining Applicable Distribution Period (ADP) What is a person s age for MRD purposes? A. Recalculation method...15 B. Fixed-term method How to determine the account balance for MRD purposes How rollovers and MRDs interact...17 A. Adjustment required for outstanding rollovers B. Other rollover effects on balance...17 C. Effect of rollover on RBD...17 D. Rollover can change applicable MRD rules Post-year-end recharacterization of Roth conversion Valuation rules for determining account balance MRDs During Participant s Life Road map: How to compute lifetime MRDs The Uniform Lifetime Table: Good news for retirees Lifetime MRDs: Much-younger-spouse method Taking distributions from multiple plans Separate accounts within a single plan The RBD and First Distribution Year Required Beginning Date (RBD): Significance RBD for IRAs and Roth IRAs QRPs: RBD for 5-percent owner QRPs, cont.: RBD for non-5-percent owner RBD for 403(b) plans (including grandfather rule ) What does retires mean?...28 A. Retirement from employer maintaining the plan B. Does retirement equal separation from service?

3 3 C. Retirement followed by re-employment? RBD versus first Distribution Year: The limbo period A. If the first year s MRD is postponed...30 B. No rollover or conversion until MRD has been taken C. Death during the limbo period Grandfather rule: TEFRA 242(b) elections Effect of 2009 one-year suspension of MRDs MRDs after the Participant s Death Overview of post-death MRD rules Road Map for determining post-death MRDs Step 1: Gather basic information...35 Step 2: Gather specialized information...35 Step 3: Determine if participant died before, on, or after RBD Step 4: Are you computing the MRD for the year of death, or later year? Step 5: Are there are multiple beneficiaries? Step 6: Do the benefits pass to a Designated Beneficiary, and if so who? Step 7: Compute the MRDs Road Map, cont.: MRDs in case of death BEFORE the RBD A. MRD for year of death (regardless of who is beneficiary) B. Surviving spouse is sole beneficiary...38 C. Individual beneficiary who is not the surviving spouse D. See-through trust...38 E. Estate, non-see-through trust, or other nonindividual beneficiary F. Multiple beneficiaries Road Map, cont.: MRDs in case of death on or AFTER the RBD A. MRD for year of death (regardless of who is the beneficiary) B. Surviving spouse is sole beneficiary...40 C. Individual beneficiary who is not the surviving spouse D. See-through trust...41 E. Estate, non-see-through trust, or other nonindividual beneficiary F. Multiple beneficiaries How to compute life expectancy of Designated Beneficiary Death before the RBD: The 5-year (sometimes 6-year) rule Life expectancy or 5-year rule: Which applies? Death after RBD: How to compute participant s life expectancy Aggregation of inherited accounts for MRD purposes Plan not required to offer stretch payout or lump sum Switching between 5-year rule and life expectancy method Who gets the benefits when the beneficiary dies What is the ADP after the beneficiary s death?

4 4 1.6 Special Rules for the Surviving Spouse Overview of the special spousal rules Definition of sole beneficiary How to determine the spouse s life expectancy A. If the spouse rolls over the benefits to her own plan B. If the spouse elects to treat an inherited IRA or Roth IRA as the spouse s own. 57 C. If the spouse is the oldest of multiple Designated Beneficiaries D. During spouse s life, if spouse is sole Designated Beneficiary E. MRDs to spouse s successor beneficiaries Required Commencement Date: Distributions to spouse Special (B)(iv)(II) rule if both spouses die young When is a trust for the spouse the same as the spouse? A. Spouse is sole beneficiary: conduit trust B. Spouse is sole beneficiary: grantor trust C. Typical QTIP-type trust: spouse is income beneficiary The Beneficiary and the Designated Beneficiary Significance of having a Designated Beneficiary Who is the participant s beneficiary? Definition of Designated Beneficiary Estate cannot be a Designated Beneficiary Multiple beneficiary rules and how to escape them Multiple beneficiaries: Who must take the MRD? A. Must year-of-death MRD be apportioned? B. Must subsequent-year MRDs be apportioned? Modifying MRD Results after Participant s Death The separate accounts rule...71 A. IRS s statement of the separate accounts rule B. Separate accounts for ADP purposes...72 C. Separate accounts for all other MRD purposes D. Pro rata sharing in gains and losses...72 E. If beneficiaries inherit through a trust or estate F. When the separate accounts become effective How do you establish separate accounts? Removing beneficiaries by Beneficiary Finalization Date A. The Beneficiary Finalization Date B. Removal by distributing beneficiary s share of benefits C. Effect of death prior to the BFD Enforcement of the MRD Rules Who enforces the minimum distribution rules Failure to take an MRD: 50% penalty and other effects

5 IRS waiver of the 50 percent penalty Statute of limitations on the 50 percent penalty Appendix A: Tables...80 Appendix B: Other Excerpts from the Book Rollover in a year in which a distribution is required Nonspouse beneficiary rollovers from nonira plan Roth IRAs and the minimum distribution rules What a see-through trust is [abbreviated version] Appendix C: Resources...88 Software...88 Newsletters...88 Quick Reference Guides...89 Choate Special Reports...89 Abbreviations and Symbols used in this Outline The paragraph symbol refers to a section of the book Life and Death Planning for th Retirement Benefits (7 ed. 2011). If the referenced paragraph begins with the number 1, or refers to Appendix B, the cross referenced section is reproduced in this Seminar Outline. Other cross referenced sections are not reproduced in this Outline. Refers to a section of the Code unless otherwise indicated. ADP Applicable Distribution Period Code Internal Revenue Code of 1986, as amended through March 31, DB Designated Beneficiary. ERISA Employee Retirement Income Security Act of FMV Fair market value. IRA Individual retirement account or individual retirement trust under 408 or 408A. IRS Internal Revenue Service. MRD Minimum Required Distribution. PLR IRS private letter ruling. QRP Qualified Retirement Plan. 401(a). RBD Required Beginning Date Reg. Treasury Regulation. WRERA The Worker, Retiree, and Employer Recovery Act of 2008 (Pub. L ).

6 6 Understanding the Minimum Distribution Rules Congress wants tax-favored retirement plans to be retirement plans, not estate-building wealth transfer vehicles. To that end, Congress enacted 401(a)(9), which compels certain annual minimum required distributions (MRDs) from plans beginning generally at age 70½ or, if earlier, death. 401(a)(9) and its related regulations are called the minimum distribution rules or the MRD rules. This Chapter explains the minimum distribution rules applicable for 2003 and later years under the IRS s final minimum distribution regulations for defined contribution plans. See for other years and other types of plans. The minimum distribution rules were suspended for defined contribution plans for the calendar year See Introduction to the MRD Rules The major attraction of the types of retirement plans discussed in this Seminar Outline ( ) is the ability to accumulate funds inside the plan on a tax-deferred basis (or tax-free, in the case of a Roth plan). The minimum distribution rules dictate when this tax-sheltered accumulation must end. 401(a)(9) tells us when benefits must start coming out of a retirement plan, and, once forced distributions start, how much must be distributed each year. Advisors need to know these rules for planning purposes because they set the outer limits on plan accumulations, and also because failure to comply with the rules involves substantial penalties ( ). The MRD rules come in two flavors: life (distributions required during the participant s life; see ); and death (distributions required after the participant s death; see ) Where to find the law Congress established the minimum required distribution (MRD) system in substantially its present form in the Tax Reform Act of The MRD rules are found in (the very brief) 401(a)(9) of the Code and in the Treasury s (very lengthy) final MRD regulations: Reg (a)(9)-0 through 1.401(a)(9)-9; 1.403(b)-6(e)(2); ; and The final regulations described in this Chapter apply to all defined contribution plan participants and beneficiaries for calendar years beginning after Reg (a)(9)-1, A-2(a); 1.403(b)- 6(e)(2); , A-1(a). For the two versions of proposed minimum distribution regulations applicable in earlier years, see the Special Report: Ancient History (Appendix C). For rules applicable to defined benefit plans ( ), see the Special Report: When Insurance Products Meet Retirement Plans (Appendix C).

7 Which defined contribution plans are subject to the MRD rules 7 For definitions of plan types referred to in this section, see 8.3 of Life and Death Planning for Retirement Benefits. The minimum distribution rules are contained in 401(a)(9), which applies to Qualified Retirement Plans (QRPs). The Code specifies that rules similar to the rules of 401(a)(9) shall also apply to IRAs ( 408(a)(6)) and 403(b) plans ( 403(b)(10)). Because the minimum distribution regulations were first written for QRPs, they refer to the participant (i.e., the individual who earned the benefits) as the employee. The Treasury has made the same regulations applicable (with certain variations) to IRAs. Reg , A-1(a). When applying the QRP regulations to an IRA, the employee is to be read as the IRA owner. Reg , A-1(b). Simplified employee pensions (SEP or SEP-IRA; 408(k)) and SIMPLE plans ( 408(p)) are treated the same as other IRAs for purposes of 401(a)(9), and accordingly are subject to the same MRD rules and regulations as regular traditional IRAs. Reg , A-2. Roth IRAs are subject to the IRA minimum distribution rules only after the participant s death; the lifetime MRD rules do not apply to Roth IRAs. See (Appendix B). The Treasury has also made its QRP MRD regulations applicable (again with certain variations) to 403(b) plans. Reg (b)-6(e) MRD economics: The value of deferral The most valuable feature of traditional tax-favored retirement plans is the ability to invest without current taxation of the investment profits. In most cases, investing through a retirement plan defers income tax not only on the investment profits but also on the participant s compensation income that was originally contributed to the plan. The longer this deferral continues, the better, because, generally, the deferral of income tax increases the ultimate value of the benefits. As long as assets stay in the plan, the participant or beneficiary is investing not just his own money but also Uncle Sam s share of the participant s compensation and the plan s investment profits, i.e., the money that otherwise would have been paid to the IRS (and will eventually be paid to the IRS) in income taxes. Keeping the money in the retirement plan enables the participant or beneficiary to reap a profit from investing the IRS s money along with his own. Once funds are distributed from the plan, they are included in the gross income of the participant or beneficiary ( 2.1), who then pays the IRS its share. Thereafter the participant (or beneficiary) will no longer enjoy any investment profits from the government s share of the plan. Long-term deferral of distributions also tends to produce financial gain with a Roth retirement plan, even though income tax is not being deferred, because it enables the money to grow tax-free for a longer period of time. Despite the apparent goal of the MRD rules (assuring that tax-favored retirement plans are used primarily to provide retirement income), 401(a)(9) permits the retirement account to stay in existence long past the death of the participant whose work created the benefit if the participant leaves his retirement benefits to the right kind of beneficiary. If various requirements are met, the law allows the retirement benefits to be paid out gradually, after the worker s death, over the life expectancy of the worker s beneficiary. The financial benefit of the long-term deferral of

8 8 distributions permitted by the minimum distribution rules puts a premium on naming a beneficiary who will qualify for this life expectancy payout method. Depending on investment returns, if the beneficiary is young, and takes no more than the MRD each year, the value of the inherited plan can soar, under the life expectancy payout method, by the time the beneficiary reaches retirement age. For example, a 38 year-old beneficiary who inherits a $500,000 traditional IRA and withdraws it using the life expectancy method ( ) will have $1,696,000 inside the IRA plus $1,432,000 outside the IRA in 30 years; if she cashes out the entire account when she inherits it, she will have (outside the IRA) only $1,470,000. This example assumes an 8% constant investment return for all assets and a 36% tax rate on all plan distributions and outside investment income; projections were prepared using Brentmark Retirement Plan Analyzer and NumberCruncher software. See Appendix C. Deferring income taxes is not always beneficial. One author argues that most people will be subject to higher income taxes when they retire and thus deferral will be a bad deal for many. See, e.g., Blyskal, Jeff, Questionable Assumptions, Worth, July/August 1993, p WRERA suspended minimum distributions for 2009 The Worker, Retiree, and Employer Recovery Act of 2008 (WRERA) amended 401(a)(9) by adding the following new subparagraph (H), entitled Temporary waiver of minimum required distribution : The requirements of [ 401(a)(9)] shall not apply for calendar year 2009 to any defined contribution plan under 401(a), 403(a) or 403(b); any governmental 457 plan; or an individual retirement plan (IRA). IRS Notices , IRB 419, and , IRB 491, provide guidance on 401(a)(9)(H). Thus, anyone who otherwise would have been required to take a distribution from one of these types of plans in 2009 whether participant or beneficiary could skip a year. Throughout this Chapter, though it may not be mentioned every single time, bear in mind that there was no MRD for the year 2009, and that: The one-year suspension generally did not change how post-2009 MRDs are calculated. It did not extend lifetime or post-death life expectancy payouts, or somehow cause the year 2009 to drop out of the calculations when determining a person s Applicable Distribution Period ( ) for MRD purposes. For example, a participant who is taking lifetime MRDs ( 1.3) will use his actual attained age in 2010 to compute the 2010 MRD, just as would have been the case if 2009 had been a normal year; he will not use his 2009 age for 2010, as if 2009 somehow did not exist. See IRS Publication 590, IRAs (2009), Examples 1 and 2 (p. 34). See also Phoebe Example, (D). For the one exception to this statement see the 5-year rule, WRERA has the effect of extending certain deadlines by one year, namely the deadlines for: Distributions under the 5-year rule for beneficiaries of decedents who died (before their RBDs) in the years (see ); the surviving spouse-beneficiary and the nonspouse Designated Beneficiary of a participant who died before his RBD to elect between a life expectancy payout and the 5-year rule ( (B)), ); and the nonspouse

9 9 Designated Beneficiary of a participant who died before his RBD to qualify for a life expectancy payout by completing a direct rollover of inherited benefits to an inherited IRA from a plan under which the 5-year rule applied. For discussion of this point, see (J) (Appendix B). But WRERA did NOT change other MRD deadlines: The Beneficiary Finalization Date remains September 30 of the year after the year of the participant s death ( ). The date by which a see-through trust must deliver documentation to the plan administrator remains October 31 of the year after the year of the participant s death ( (A)). The date by which multiple beneficiaries must establish separate accounts for purposes of determining their Applicable Distribution Period (ADP) remains December 31 of the year after the year of the participant s death ( (B)). The participant s RBD remains April 1 of the year after he reaches age 70½ (or retires, whichever is applicable) for purposes of determining whether he died before or after his RBD ( , Step 3), even if he reached age 70½ in 2008 or Although in theory there were no MRDs in 2009, actually there were MRDs that had to be paid, even in Any 2008 MRD that was postponed until April 1, 2009, where 2008 was the first distribution year still had to be taken by April 1, 2009; see (A). Regarding skipped MRDs from any year earlier than 2009, see (A); these are still considered MRDs when distributed in 2009 (meaning they cannot be rolled over). See IRS Notice , Part V, A-8. For the effect on individuals who turned age 70½ in 2008 or 2009, see Despite WRERA s suspension of MRDs, some plans distributed 2009 required distributions anyway. The IRS granted participants and surviving spouses (but not other beneficiaries) who received these nonrequired required distributions the right to roll them over within 60 days of receipt (or by November 1, 2009, if later); see the Special Report: Ancient History (Appendix C) Ten planning ideas (good and bad) for MRDs Here are some planning ideas related to MRDs. indicates a highly recommended step for everyone. signifies a valid planning idea that will work for some people, or a planning consideration with arguments on both sides. indicates something to avoid. 1. Review your beneficiary designations early and often to make sure you have named the best choice. Verify that your plan administrator or IRA provider and you agree on who your beneficiary is.

10 10 2. Make sure your beneficiaries and executor know about all your retirement plans and what their options will be. Head off the inadvertent post-death distributions and other catastrophes suffered by non-knowledgeable beneficiaries and fiduciaries. 3. File Form 5329 with your income tax return EVERY year after age 70½ (or if you hold an inherited retirement plan), attaching an explanation of how you calculated your MRD. See (B). 4. In years when qualified charitable distributions (QCDs) are permitted ( , as of this writing), use a QCD to satisfy your MRD, if you are charitably inclined. In these years, individuals who are over age 70½ are permitted to make charitable gifts (up to $100,000 per year) directly from their IRAs, without having such gifts be includible in their gross income. A QCD will count as a distribution for purposes of determining whether an individual has fulfilled the MRD requirement. See IRS Notice , A-42. For more on QCDs, see 408(d)(8), Notice , I.R.B. 395, Part IX, and the Natalie Choate Special Report: Recent Developments (Appendix C). 5. Postponing the first year s MRD (see ) creates a mismatch in the IRS s computers: Your IRA provider will report (on Form 5498) that a distribution was required for the age 70½ year, but there will be no 1099-R filed showing a distribution was taken, possibly triggering an audit. Don t take that risk unless you expect a worthwhile financial benefit. See Bernie Example, (A). 6. See (D) for how to use rollovers to stop or prevent MRDs. 7. Should you leave one IRA to multiple beneficiaries? Or multiple IRAs to separate individuals? See Always take your MRD early in the year, so that this task is taken care of and you don t have to worry about it. But take your MRD late in the year in case Congress decides to add more favorable ways to take the MRD in the middle of the year, as happened in 2006, 2008, 2010, and 2012, when Congress enacted or reinstated QCDs (see #4 above) retroactively to the beginning of each such year. 9. Don t sell investments inside your IRA just to have enough cash to pay your MRD. Save the commissions; take MRDs in kind instead. See (E). 10. Avoid schemes purporting to reduce the size of MRDs by reducing the value of your retirement benefits via investment in some type of discounted entity.

11 MRD Fundamentals This 1.2 explains the components of the minimum distribution system The 12 Fundamental Laws of the MRD Universe Here are the basic principles underlying the minimum required distribution (MRD) scheme for defined contribution plans. Note that many rules have at least one exception! 1. MRDs start at a particular time. The starting point for lifetime required distributions is approximately age 70½ (or upon later retirement in some cases); see 1.4 for explanation of the first Distribution Year and the Required Beginning Date. The final Distribution Year for lifetime distributions is the year of the participant s death (A). The starting point for post-death MRDs is measured from the participant s death , The MRD must be taken by December 31 each year. Once MRDs begin, the participant or beneficiary must take a distribution each and every calendar year, no later than December 31, as long as he lives (or until the plan runs out of money). Reg (a)(9)-5, A-1. There are several exceptions to this rule. First, the 5-year rule does not require annual distributions; see Second, in the case of certain lifetime MRDs, the distribution for the first Distribution Year can be postponed until the Required Beginning Date (which occurs in the following year); see 1.4. Third, there were no MRDs for the year 2009; see Fourth, see (D) for how to use rollovers to stop MRDs. Finally, MRDs can be delayed beyond the normal deadline in two situations: a review period for QDROs and (in the case of insured plans) delay caused by receivership of the insurance company; see Reg (a)(9)-8, A-7, A-8, for these exceptions. 3. Each year s MRD is determined by dividing the prior year-end account balance by a factor from an IRS table. MRDs are computed by dividing an annually-revalued account balance by an annually-declining life expectancy factor. Reg (a)(9)-5, A-1(a). (Exception: This principle does not apply to post-death distributions under the 5-year rule ) This life expectancy factor is obtained from an IRS table and is called the Applicable Distribution Period (ADP) or divisor; see for more on the definition of these terms and where to find the IRS tables. The ADP is a divisor, not a percentage; see Kenny Example, For how to determine the account balance, see There is no maximum distribution. The formula tells you the minimum required distribution. The rules impose no maximum distribution; the participant or beneficiary is always free, as far as the IRS is concerned, to take more than the minimum (but see #6). 5. Taking more than the required amount in one year does not give you a credit you can use to reduce distributions in a later year. Each year stands on it own. Reg (a)(9)-

12 12 5, A-2. Taking larger distributions in one year indirectly reduces later MRDs by reducing the account balance. 6. The plan is not required to offer every option the law permits.. Generally participants and beneficiaries must accept whatever distribution options the plan happens to offer, provided the plan does not call for slower distributions than the minimum distribution rules would require. See The MRD cannot exceed 100 percent of the account balance....[t]he required minimum distribution amount will never exceed the entire account balance on the date of the distribution. Reg (a)(9)-5, A-1(a). This rule can help if the account is wiped out before the MRD is taken; see Distributions before the first Distribution Year don t count. The first year for which an MRD is required is called the first Distribution Year. See 1.4. Distributions in years prior to that year have no effect on the computation of the MRD for the first (or any other) Distribution Year (other than indirectly, by reducing the account balance). Reg (a)(9)-2, A-6(a). 9. Distribution period does not involve an election. Generally, determination of the ADP for benefits, either during the participant s life or after his death, does not involve an election on the part of the participant or beneficiary. The ADP is prescribed by law based on the identity of the participant and beneficiary. (This is in contrast to the now-obsolete 1987 proposed regulations, under which the participant had to make various irrevocable elections at his RBD.) For the exceptions to this rule, see (if the participant dies before his RBD, leaving his benefits to a Designated Beneficiary, the beneficiary may have to elect between the life expectancy payout method and the 5-year rule) and (surviving spouse may elect or be deemed to have elected to treat an inherited IRA as the spouse s own IRA). 10. The regulations overrule the Code. You cannot compute an MRD simply by following the Internal Revenue Code. The IRS regulations have fundamentally altered the Code s approach in several ways. For example, the Code dictates that lifetime distributions must be made over the life expectancy of the participant or the joint life expectancy of the participant and his beneficiary. 401(a)(9)(A)(ii). The regulations make the identity and life expectancy of the beneficiary almost irrelevant; see 1.3. For other examples of the IRS s overruling the Internal Revenue Code, see ( General Comments ) and MRDs are determined under the rules applicable to the plan that holds the benefits, not under the rules of some prior plan that the benefits may previously have resided in. Reg (a)(9)-7. See (D).

13 Missing an MRD has consequences. A participant or beneficiary who misses an MRD becomes liable for a penalty; see Which distributions count towards the MRD Regs (a)(9)-5, A-9(a), and , A-11(a), state that, except as otherwise provided in A-9(b) or A-11(b) of such regulations, or as may later be otherwise provided by other IRS pronouncements, all amounts distributed from a plan or IRA are taken into account in determining whether section 401(a)(9) is satisfied. Here is the MRD status of various distributions: A. Distribution of an annuity contract does not count. When an employee s plan account or IRA balance is used to purchase an annuity contract, distributions under the contract must comply with MRD rules. Reg (a)(9)-5, A-1(e), 1.401(a)(9)-8, A-2(a)(3). Distribution of a nonassignable annuity contract that complies with the MRD rules is a nontaxable event ( (G)) and does not count as a distribution for MRD purposes. Reg (a)(9)-8, A-10. B. Corrective and deemed distributions do not count. QRP contributions that are returned to the participant because they exceeded various contribution limits do not count towards the MRD requirement. Reg (a)(9)-5, A-9(b)(1) (3). IRA contributions returned (together with the earnings thereon ) by the extended due date of the participant s tax return ( corrective distributions ) do not count. Reg , A-11(b)(1) (3). Neither do plan loans that are treated as distributions due to failure to comply with the plan loan rules, or the imputed income arising from life insurance held by a plan (see the Special Report: When Insurance Products Meet Retirement Plans, Appendix C). Reg (a)(9)-5, A-9(b)(4), (6). For details on corrective distributions, see of Life and Death Planning for Retirement Benefits; for details on deemed distributions arising from plan loans, see C. ESOP dividends do not count. Dividends on employer stock held in an ESOP can be paid by the stock s issuer directly to the participant or beneficiary. 404(k). Such dividend payments do not count towards the MRD requirement. Reg (a)(9)-5, A-9(b)(5). D. Nontaxable distributions do count. For two exceptions to this rule see A and B. Reg (a)(9)-5, A-9(a), , A-11(a). See PLR (discussed at (B) of Life and Death Planning for Retirement Benefits). The nontaxable portion of a QRP distribution is applied first to the MRD. Reg (c)-2, A-8. If the MRD amount exceeds the nontaxable portion of the distribution, then the rest of the MRD is filled up from the taxable portion. Any balance of the taxable portion remaining after the MRD is satisfied is eligible for rollover. See if the employee has multiple accounts in a QRP. For full discussion of the rule that an MRD is not an eligible rollover distribution, see (Appendix B); for how to tell what portion of a particular distribution is nontaxable, see 2.2.

14 14 E. Distributions in kind do count. For an exception to this rule see A. A participant or beneficiary can take MRDs in kind as well as in cash. Plans are permitted to distribute property as well as cash. See Instructions for IRS Forms 1099-R (2013), pp. 9 10, where the payer is instructed If you distribute employer securities or other property, include in box 1 the FMV of the securities or other property on the date of distribution. Emphasis added. F. Trustee-to-trustee transfers generally do not count. A direct transfer from one IRA to another IRA of the same type (traditional or Roth) is not treated as a distribution for purposes of fulfilling the MRD requirement. Reg , A-8(a). A different rule applies to a transfer that is treated as a rollover, i.e., a direct rollover from a QRP or 403(b) plan to an IRA or Roth IRA, or a transfer (conversion) from a traditional IRA to a Roth IRA. For trustee-to-trustee transfers that are treated as rollovers or conversions, the MRD is supposed to be distributed to the participant or beneficiary before the transfer or conversion occurs. If that is not done (i.e., at the time of the rollover or conversion the MRD has not yet been taken), then the rollover or conversion itself is considered a distribution that counts towards fulfilling the MRD requirement. However, the rollover or conversion will be invalid to the extent it counts as fulfilling the MRD requirement for the distributing plan, because an MRD is not an eligible rollover distribution. See Reg A-4, A-6; for discussion, see the Special Report: IRAs with Hair, downloadable at Part 1.1. For details on the difference between rollovers and plan-to-plan transfers, see (C) and (D) pf Life and Death Planning for Retirement Benefits; for more on rollovers and transfers that are also Roth conversions, see (E) (Appendix B) and IRS tables for determining Applicable Distribution Period (ADP) MRDs are determined annually by dividing the prior year-end account balance by a life expectancy factor supplied by the IRS. In the regulations terminology, the tables supply the Applicable Distribution Period (ADP) or divisor. Note: The term ADP is used to mean both, particularly, the numerical factor used as a divisor in computing the MRD for a particular year ( , #3) and, more generally, the payout period that will apply to a particular participant or beneficiary, as in the ADP is the oldest beneficiary s life expectancy ( (B)). There are currently three tables in use for purposes of computing MRDs. All three tables are reproduced in full in IRS Publication 590, Individual Retirement Arrangements. All three tables are unisex (life expectancy for men and women is the same). Lifetime MRDs ( 1.3) are calculated using either the Uniform Lifetime Table ( ) or (if the participant s sole beneficiary is his more-than-10-years-younger spouse) the Joint and Last Survivor Table The Uniform Lifetime Table is found at Reg (a)(9)-9, A-2, and in Appendix A of this Seminar Outline. The Joint and Last Survivor Table is found at Reg (a)(9)-9, A-3. Post-death MRDs based on the life expectancy of the surviving spouse ( (C), (D)); of a nonspouse Designated Beneficiary ( ); or of the deceased participant ( ); are calculated using the Single Life Table. The only post-death MRDs not governed by the Single Life Table are the MRD for the year of the participant s death ( (A)) and distributions under the

15 15 5-year rule ( ). The Single Life Table is found at Reg (a)(9)-9, A-1, and in Appendix A of this Seminar Outline. The IRS uses a different set of actuarial tables for estate and gift tax valuations; see The estate and gift tax actuarial tables must be revised (updated) at least every 10 years. 7520(c)(3). The 2009 updates to the transfer tax actuarial tables have no effect on the calculation of MRDs. The tables used to calculate MRDs were last updated in T.D. 8987, 67 FR They may be updated from time to time by the IRS. Reg (a)(9)-9, A What is a person s age for MRD purposes? To obtain the ADP or divisor ( ) from the IRS tables, you need to know the participant s or beneficiary s age. Age for MRD purposes means the age the person will attain on his birthday in the applicable Distribution Year; it is the age he will be at the end of the Distribution Year. Reg (a)(9)-5, A-4(a), (b); A-5(c). The tricky part is that for some MRDs the age is determined only once, at the beginning of the payout period; this is called the fixed-term or reduce-by-one method. For other MRDs, the age is redetermined annually ( recalculation method ). The participant or beneficiary has no choice in this matter the regulations dictate which method applies in which situation. A. Recalculation method. The recalculation method applies for purposes of computing all lifetime MRDs ( 1.3), including the MRD for the year of the participant s death if any ( (A)), and post-death MRDs when the surviving spouse is the sole beneficiary ( (D)). Under the recalculation method, the individual s age is redetermined each year, and the ADP used is the divisor applicable to the new age, instead of just deducting one from last year s divisor. Under the recalculation method, life expectancy never runs out as long as the distributee is alive: See ; Kenny Example ( ); and Josephine Example ( (D)). B. Fixed-term method. Under the fixed-term method, you determine the person s age and the corresponding ADP in the first Distribution Year. In subsequent Distribution Years, the divisor is simply the prior year s divisor reduced by one; see Diane Example at (A). Some call this the reduce-by-one method. Unlike with the recalculation method, you do not determine a new ADP each year based on the person s new age. With two exceptions, the fixed-term method is always used after the participant s death to determine MRDs to the beneficiary. The two exceptions are: the MRD for the year of the participant s death ( (A)); and MRDs during the surviving spouse s life, if she is the participant s sole beneficiary ( (D)). The fixed-term method is never used to calculate MRDs during the participant s lifetime.

16 How to determine the account balance for MRD purposes 16 Each year, the MRD is determined by dividing the prior year-end account balance by the ADP. This section explains which account balance you use and what adjustments are required. See for how to value the account balance. The relevant account balance for an IRA is the account balance of the IRA as of December 31 of the calendar year immediately preceding the calendar year for which distributions are required to be made. Reg , A-6. In the case of a qualified retirement plan (QRP), use the account balance as of the last valuation date in the calendar year immediately preceding the Distribution Year. Reg (a)(9)-5, A-3(a). Here are the adjustments that are then required (or not allowed) with respect to this account balance: The balance must be increased by the amount of any outstanding rollover (rollover in transit as of the last day of the year). See (A). The balance must be increased by the amount of any post-year-end recharacterization of a Roth conversion that occurred in the prior year. See In determining MRDs for 2011 (or 2013), the prior-year-end balance for 2010 (or 2012) of an IRA must be reduced by the amount of any qualified charitable distribution (QCD) withdrawn from the account in January of 2011 (or 2013) that the participant (or beneficiary) elected to treat as a QCD for 2010 (or 2013). See (with respect to January 2011 distributions) 752(b)(2) of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Pub. L ); (with respect to January 2013 distributions) 208 of the American Taxpayer Relief Act of 2012; (with regard to QCDs generally) 408(d)(8); and If the participant chooses to postpone the MRD for the first Distribution Year into the second Distribution Year (see ), the prior year-end account balance is NOT reduced by the amount of the postponed MRD when computing the MRD for the second Distribution Year. T.D. 8987, C.B. 852, 858, Calculation Simplification. Regarding the possibility of a reduction of the prior year-end account balance by the amount of any MRDs that were missed (not distributed) in prior years, see Finally, with one exception, there is no adjustment allowed for post-year-end decreases in the value of the account, such as could occur through investment losses, a divorce in which part of the account is transferred to the participant s ex-spouse, or a creditor s seizing the account. The exception: The only adjustment recognized for this type of change in value is that the MRD is reduced as necessary so that it does not exceed the entire account balance on the date of the distribution. See , #7.

17 17 Biff Example: Biff s IRA is worth $1 million as of 12/31/12. He turns 74 in 2013, so his 2013 MRD is $42,017. In 2013, he gets divorced, and the divorce court awards Mrs. Biff half of Biff s IRA in a tax-free split under 408(d)(6), so Biff s IRA is reduced to approximately $500,000. Biff still has to take out $42,017 in If the divorce court had awarded the entire account to Mrs. Biff, reducing Biff s account balance to zero before he had taken his 2013 MRD, the 2013 MRD would be reduced to zero because the MRD can never exceed the value of the account on the date of distribution (every cloud has a silver lining) How rollovers and MRDs interact This explains how rollovers and plan-to-plan transfers affect application of the minimum distribution rules. See also (regarding recharacterization of Roth IRA conversions). For explanation of the difference between rollovers and plan-to-plan transfers, see of Life and Death Planning for Retirement Benefits. A. Adjustment required for outstanding rollovers. You must increase the prior year-end balance ( ) by any amount that was added to the account in the Distribution Year ( Year 2 ) and that represented a rollover from another plan or IRA, if the amount in question was distributed from such other plan or IRA in the prior calendar year ( Year 1 ). The IRS calls such rollovers that are in transit from one account or plan to another on the last day of the year outstanding rollovers. For purposes of computing MRDs for the receiving plan, the rollover amount is deemed to have been received in the prior calendar year (i.e., Year 1) and not the year it was actually received (Year 2). Reg (a)(9)-7, A-2, last sentence. If this rule did not exist, people could cheat by moving money around from account to account at the end of the year, so as to avoid having the funds count as part of the year-end account balance of either plan. [Note: Reg (b)(6)(v), which states the opposite rule (outstanding rollovers were added back to the distributing plan) was rendered obsolete by the final MRD regulations. See Reg , A-1.] B. Other rollover effects on balance. Reg (a)(9)-7 contains other rules regarding the effect of rollovers and plan-to-plan transfers on the calculation of MRDs, but (with the exception noted in A ) a rollover into a plan or IRA has no effect on MRDs from that plan or IRA until the year after the rollover is received. Reg (a)(9)-7, A-2. The rollover has the effect of increasing the plan balance of the receiving plan, which increases the MRD for the year following the rollover. C. Effect of rollover on RBD. Generally, if a rollover contribution is made into a brand new IRA (an account which contained nothing at the time it received the rollover), there is no distribution required from such new IRA for the year in which the rollover contribution comes into the new account, because the prior year-end account balance was zero (for exceptions see A and ). The required beginning date (RBD; ) for the new

18 18 account will be the later of (1) April 1 of the year after the year the participant reaches age 70½ or (2) December 31 of the year after the year of the rollover. See PLRs , D. Rollover can change applicable MRD rules. MRDs are determined under the rules applicable to the plan that holds the benefits, not the plan that the benefits were in prior to a rollover. See Reg (a)(9)-7. This means that a rollover can change the MRD rules applicable to the rolled over assets. There are three situations in which an individual can use a rollover to stop (or head off) the flow of required distributions. Of course he must withdraw the MRD for the year of the rollover (if any) before doing the rollover; see (Appendix B). A participant who is over age 70½, and therefore is forced to take MRDs from his traditional IRAs (and from any QRPs maintained by any employer as to which the participant is a 5-percent owner), can staunch the flow of MRDs if he is still working (for an employer as to which he is not a 5-percent owner and which maintains a QRP that accepts rollovers), by rolling over the benefits to this employer s QRP. See and PLR A participant can stop or prevent MRDs by rolling traditional plans and IRAs and designated Roth accounts (also called Roth 401(k), Roth 403(b), or Roth 457(b) accounts; see 5.7 of Life and Death Planning for Retirement Benefits) to a Roth IRA, because Roth IRAs are not subject to the minimum distribution rules until after the participant s death. See (Appendix B). A surviving spouse beneficiary can roll over, to her own IRA, benefits inherited from the deceased participant, and thereby: Delay the start of (if the decedent was older than the spouse) and/or substantially reduce (once they start) MRDs (see (D)); or eliminate MRDs for the inherited benefits altogether by rolling over the benefits to her own Roth IRA (because Roth IRAs are not subject to the minimum distribution rules until after the participant s death). For more on Roth conversions by the surviving spouse, see (B) and of Life and Death Planning for Retirement Benefits Post-year-end recharacterization of Roth conversion A Roth IRA conversion can be recharacterized (reversed or undone) by moving the conversion contribution out of the Roth IRA it was contributed to and depositing it, using a planto-plan transfer, into a traditional IRA. For complete explanation of Roth conversions and recharacterizations, see 5.4 and 5.6, respectively, of Life and Death Planning for Retirement Benefits. If there is a Roth conversion in a particular year ( Year 1 ), and that conversion is recharacterized in the following year ( Year 2 ; see of Life and Death Planning for

19 19 Retirement Benefits for the applicable deadline), the recharacterized conversion contribution (and the net income or loss allocable to it, which must be transferred to the traditional IRA along with the contribution itself in order to have a valid recharacterization) is added to the year-end account balance of the traditional IRA that received the recharacterized amount, for purposes of computing the MRD for the year of the conversion. This rule applies to recharacterizations of failed Roth conversions as well as recharacterizations of valid Roth conversions. Reg , A-8(b). Note that the amount added to the prior year-end balance is the amount that is actually transferred into the traditional IRA, NOT the prior year-end balance of the Roth IRA itself. Thor Example: Thor turns age 75 in He owns a traditional IRA (IRA #1). He owns no other IRAs. On January 4, 2012, he withdraws his 2012 MRD from IRA #1, then transfers the remaining balance ($1 million) to a brand new separate Roth IRA (Roth IRA X), closing out IRA #1. He makes no other contributions to (and takes no distributions from) these or any other Roth or traditional IRA accounts. He does not recharacterize the Roth conversion in On December 31, 2012, his traditional IRA balance is zero, and the value of Roth IRA X is $950,000. It appears that (because the only IRA he owns is a Roth IRA) Thor will have no MRD in However, in August 2013, when the Roth IRA is worth only $900,000, he recharacterizes his 2012 conversion. He does this by transferring the original contribution plus the net income attributable to the contribution into a traditional IRA (IRA #2). The net income attributable to the $1 million contribution is a loss of $100,000, so the amount transferred from Roth IRA X to IRA #2 is $900,000. The $900,000 so transferred (NOT the actual prior year-end value of the Roth IRA, which was $950,000) must be included in computing the prior year-end balance of IRA #2 for purposes of computing Thor s traditional-ira MRD for 2013 (even though he had no traditional IRA at all on 12/31/2012). He must take an MRD from IRA #2 in 2013, based on the hypothetical prior-year-end balance of $900,000. Although regular (annual-type) contributions to a Roth IRA or traditional IRA can also generally be recharacterized as a contribution to the other type of IRA, the special rule of Reg , A-8(b), does not apply to recharacterizations of regular contributions. It applies only to recharacterized conversion contributions, for a very good reason. An individual cannot make a contribution to a traditional IRA in the year he attains age 70½ or any later year. 219(d)(1). Thus, an individual who is subject to the lifetime MRD rules (which apply to a traditional IRA beginning in the age-70½ year; ) cannot make a regular contribution to a traditional IRA. He can (if he has compensation income, and his adjusted gross income is below certain levels) make a regular contribution to a Roth IRA, but he should not recharacterize that contribution as a contribution to a traditional IRA because he is forbidden to make a regular contribution to a traditional IRA; such a recharacterization would be an excess IRA contribution. For explanation of the difference between regular and rollover IRA contributions, and eligibility to make regular contributions to both types of IRA, see 5.3 of Life and Death Planning for Retirement Benefits; regarding excess IRA contributions (including what constitutes; penalty for making the same; and ways to mitigate), see

20 Valuation rules for determining account balance explain which account balance is used and what adjustments to the balance are required. But the most important thing about that account balance is its value. The value of the account balance is what the Applicable Distribution Period (ADP or divisor ; see ) is divided into to determine the MRD. IRA providers are required to provide the year-end fair market value (FMV) of the IRA to the IRS annually on Form Surprisingly, except for one rule discussed below, there is no guidance on how to determine FMV for MRD purposes. IRS Notices , CB 814, and , CB 257, both providing guidance to IRA providers regarding their reporting requirements under Reg , A-10, contain no valuation rules. Watch this Space! There is political pressure on the IRS to get more involved in policing IRA valuations. In early 2013, the General Accounting Office announced it is going to investigate whether the IRS is properly enforcing IRA valuation rules. The trigger for this concern was a demand by four Democratic Senators who in turn were prompted by a woman who called in to a tv talk show asking how Mitt Romney s IRA could have reached a purported value of $100 million when the maximum annual contribution is only $6,000, then answered her own question saying it must have been by means of fraudulent stock undervaluations. Someone needs to tell this lady about rollovers, and someone should have pointed out that Romney s election disclosure form said the value was between $20 million and $100 million, so it may not in fact be worth $100 million. Whatever, Mitt s disclosure form could mean stricter valuation enforcement for the rest of us! There is one special valuation rule, governing how an annuity contract held inside a defined contribution plan is to be valued for MRD purposes. See Reg (a)(9)-6, A-12(a). The special MRD valuation rule for annuities may NOT be used to value a contract for purposes of a Roth IRA conversion; see (A) of Life and Death Planning for Retirement Benefits regarding this rule. It applies only to annuity contracts that have not been annuitized; its primary application is to variable annuity contracts. Generally, the value of the variable annuity contract for MRD purposes is (1) its cash value ( the dollar amount credited to the employee or beneficiary under the contract ) plus (2) the actuarial present value of any additional benefits (such as survivor benefits in excess of the [cash value]) that will be provided under the contract. The actuarial present value must be determined using reasonable actuarial assumptions, but without regard to any individual s actual health. Reg (a)(9)-6, A-12(b). There are two exceptions to this special valuation rule. First, if the only additional benefit provided by the contract is a death benefit equal to the total premiums paid (minus prior distributions), such additional benefit can be disregarded in valuing the contract for MRD purposes. Reg (a)(9)-6, A-12(c)(2). Second, if the contract provides additional death and/or life benefit guarantees beyond the mere return of premiums, it may still be possible to disregard the contract s additional benefits for MRD purposes but only if the additional benefits meet complicated tests contained in Reg (a)(9)-6, A-12(c). To take advantage of this disregard provision, the