Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans

Transcription

1 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans WSU Accounting & Auditing Conference Tuesday, May 20, 2014 Presented By: Steven P. Smith Hinkle Law Firm LLC 301 North Main Street, Suite 2000 Wichita, Kansas (316) Jason P. Lacey Foulston Siefkin LLP 1551 N. Waterfront Parkway, Suite 100 Wichita, Kansas (316)

2 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 1 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Table of Contents Page I. INTRODUCTION... 1 II. ASSETS SUBJECT TO RMD RULES... 1 III. OVERVIEW OF RMD RULES... 3 IV. THE NON-SPOUSE BENEFICIARY ROLLOVER RULE V. MISCELLANEOUS VI. RMD EXAMPLES I. INTRODUCTION. The required minimum distribution (RMD) rules of Section 401(a)(9) of the Internal Revenue Code (the Code ) present one of the more complex compliance regimes applicable to individuals holding retirement and retirement-type assets. This outline provides a brief overview of the RMD rules and highlights a few of the issues that individuals and their advisors commonly encounter when considering the RMD rules in connection with estate planning or administration. II. ASSETS SUBJECT TO RMD RULES. A number of retirement-type assets are subject to the RMD rules. See Treas. Reg (a)(9)-1, Q&A-1. A. Qualified Plans. Retirement plans qualified under Section 401(a) of the Code (e.g., stock bonus, pension, and profit-sharing/401(k) plans). Source of Rules: I.R.C. 401(a)(9); Treas. Reg (a)(9)-1 through 1.401(a)(9)-9

3 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 2 B. 403(b) Plans. C. IRAs. Annuity contracts or custodial accounts governed by Section 403(b) of the Code. Source of Rules: I.R.C. 403(b)(10) and 401(a)(9); Treas. Reg (b)-3 and 1.401(a)(9)-1 through 1.401(a)(9)-9 Traditional individual retirement accounts and individual retirement annuities governed by Section 408 of the Code. Source of Rules: I.R.C. 408(a)(6), 408(b)(3), and 401(a)(9); Treas. Reg and 1.401(a)(9)-1 through 1.401(a)(9)-9 D. Roth IRAs. Roth individual retirement accounts and individual retirement annuities governed by Section 408A of the Code, but only after the death of the Roth IRA owner. Roth IRAs are not subject to the RMD rules during the lifetime of the Roth IRA owner. Source of Rules: I.R.C. 408A(c)(5) and 401(a)(9); Treas. Reg A-6 and 1.401(a)(9)-1 through 1.401(a)(9)-9 E. Roth 401(k) Accounts. 401(k) plans may now offer Roth accounts within the plans. However, there is no exception from the general RMD rules applicable to 401(k) plans for the Roth portion of a 401(k) plan (see paragraph A. above). Thus, amounts in a Roth 401(k) account are subject to RMD requirements while they remain in the plan. Note. In many cases, amounts in a Roth 401(k) account may be rolled over to a Roth IRA (if there is a distributable event and the amounts constitute an eligible rollover distribution). In that case, the RMD requirements under Code Section 408A would apply and generally would permit delaying all distributions during the individual s lifetime.

4 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 3 F. 457 Plans. Eligible retirement plans of tax-exempt and governmental employers governed by Section 457 of the Code. Source of Rules: I.R.C. 457(d)(2) and 401(a)(9); Treas. Reg and 1.401(a)(9)-1 through 1.401(a)(9)-9 III. OVERVIEW OF RMD RULES. A. Distributions Beginning During Lifetime. In general, benefit payments from a plan, account, or contract subject to the RMD rules must commence not later than the required beginning date, and the entire benefit must be paid over a period not longer than the life expectancy of the payee or the joint life expectancy of the payee and the payee s designated beneficiary. See Treas. Reg (a)(9)-2, Q&A-1(a). 1. Required Beginning Date. The required beginning date generally is April 1 of the calendar year following the later of: a. The calendar year in which the payee reaches age 70½; or b. In the case of an employee plan, the calendar year in which the payee terminates employment with the employer maintaining the plan. However, in the case of an employee plan, if the payee is a 5% owner of the employer maintaining the plan, the required beginning date for that payee is April 1 of the calendar year following the calendar year in which the payee reaches age 70½. See Treas. Reg (a)(9)-2, Q&A Payment Period. a. General Rule: Uniform Lifetime Table. In general, for RMDs during years up to and including the year of the payee s death, payments must be made over a period determined under a Uniform Lifetime Table provided in Section 1.401(a)(9)-9, Q&A-2 of the Treasury Regulations. See Treas. Reg (a)(9)-5, Q&A-4(a) (account balance plans) and 1.401(a)(9)-6, Q&A-3(a) (annuity contracts). The payment period

5 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 4 for purposes of determining the RMD in a particular year is determined using the payee s age as of the payee s birthday in that year. b. Exception: Spouse is Sole Beneficiary. If the payee s spouse is the payee s sole designated beneficiary, the payee is permitted to use a payment period that is the longer of: i. The period determined under the Uniform Lifetime Table; or ii. The joint life expectancy of the payee and the payee s spouse, determined under a table provided in Section 1.401(a)(9)-9, Q&A-3 of the Treasury Regulations, using the ages of the payee and the spouse as of their birthdays during the relevant calendar year. A payee s spouse is the payee s sole designated beneficiary for a given year only if the spouse is the sole beneficiary of the payee s entire interest at all times during that year. However, if the spouse dies or the payee and the spouse are divorced during a year, the payee may still qualify for this exception, even though someone other than the payee s spouse is named as a beneficiary for the remainder of the year. See Treas. Reg (a)(9)-5, Q&A-4(b) (account balance plans) and 1.401(a)(9)-6, Q&A-3(a) (annuity contracts). B. Death of Payee After Distributions Have Begun. When the payee dies after RMDs have begun, different rules apply for purposes of determining the RMD for the year of the payee s death and for subsequent years. 1. Required Minimum Distribution in Year of Death. As noted above, for calendar years up to and including the year of death, the RMDs must be determined using the Uniform Lifetime Table, applying the payee s age as of the payee s birthday in the relevant calendar year. For the year of the payee s death, the RMD is determined as if the payee had lived throughout that year and must be made to the beneficiary to the extent it has not already been distributed to the payee prior to death. See Treas. Reg (a)(9)-5, Q&A-4(a).

6 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 5 2. Required Minimum Distributions in Years after Year of Death. For calendar years beginning after the year of the payee s death, the distribution period is determined as follows: a. If the payee has a designated beneficiary within the meaning of the regulations, the distribution period is the longer of: i. The remaining life expectancy of the designated beneficiary; or ii. The remaining life expectancy of the payee. b. If the payee does not have a designated beneficiary, the distribution period is the remaining life expectancy of the payee. See Treas. Reg (a)(9)-5, Q&A-5(a). Accordingly, the calculation of RMDs in this instance requires a determination whether the employee or IRA owner has a designated beneficiary and, if so, what the remaining life expectancy of that beneficiary is relative to the payee s remaining life expectancy. (See Part III.D. below for further discussion regarding the determination whether a payee has a designated beneficiary.) C. Distributions Beginning After Death. If the employee or IRA owner dies before RMDs are required to begin (generally, before reaching the required beginning date ), two questions must be answered: When are payments required to begin and over what period are they required to be made? 1. Commencement Date. One of three rules determines when RMDs are required to begin. Which rule applies will depend on the terms of the plan or IRA and whether the employee or IRA owner has a designated beneficiary within the meaning of the RMD rules. (See Part III.D. below for further discussion regarding the determination whether an employee or IRA owner has a designated beneficiary.) a. 5-Year Rule. Under the 5-year rule, the entire plan or IRA interest must be distributed not later than the end of the calendar year containing the fifth anniversary of the employee s or IRA owner s death. See

7 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 6 Treas. Reg (a)(9)-3, Q&A-2. The 5-year rule generally applies only if the employee or IRA owner does not have a designated beneficiary. However, the plan or IRA may, by its terms, either require application of the 5-year rule or permit election between the 5-year rule and the life-expectancy rule described below. See Treas. Reg (a)(9)-3, Q&A-4. b. Life-Expectancy Rule: Non-Spouse Beneficiary. Under the life-expectancy rule, if the employee s or IRA owner s beneficiary is an individual other than the employee s or IRA owner s spouse, RMDs are required to begin by the end of the calendar year after the year of the employee s or IRA owner s death. See Treas. Reg (a)(9)-3, Q&A-3(a). The lifeexpectancy rule generally applies when the employee or IRA owner has a designated beneficiary. However, as noted above, the plan or IRA may, by its terms, either require application of the 5- year rule or permit election between the 5-year rule and the lifeexpectancy rule. See Treas. Reg (a)(9)-3, Q&A-4. c. Life-Expectancy Rule: Spouse Beneficiary. If the life-expectancy rule applies and the employee s or IRA owner s designated beneficiary is the employee s or IRA owner s spouse, RMDs are required to begin by the later of: i. The end of the calendar year after the year of the employee s or IRA owner s death; or ii. The end of the calendar year in which the employee or IRA owner would have reached age 70½, had the employee or IRA owner lived. 2. Payment Period. See Treas. Reg (a)(9)-3, Q&A-3(b). If RMDs are required to be made in accordance with the 5-year rule, by definition the payment period cannot last longer than 5 years. However, if RMDs are permitted or required to be made in accordance with the lifeexpectancy rule, the payment period depends on whether the designated beneficiary is the spouse of the employee or IRA owner.

8 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 7 a. Non-Spouse Beneficiary. If the designated beneficiary is an individual other than the employee s or IRA owner s surviving spouse, the payment period is determined initially under the Uniform Lifetime Table using the beneficiary s age in the calendar year after the year of the employee s or IRA owner s death. Thereafter, the payment period is determined by subtracting one from the number of years in the payment period for the prior year. See Treas. Reg (a)(9)-5, Q&A-5(c)(1). b. Spouse Beneficiary. D. Designated Beneficiaries. If the sole designated beneficiary is the employee s or IRA owner s surviving spouse, the payment period is determined under the Uniform Lifetime Table each year, using the surviving spouse s age as of his or her birthday in that year. In the year the surviving spouse dies, the payment period is fixed based on the surviving spouse s age in that year. Thereafter, the payment period is determined by subtracting one from the number of years in the payment period for the prior year. See Treas. Reg (a)(9)-5, Q&A-5(c)(2). Many of the RMD rules depend on whether the employee or IRA owner has a designated beneficiary and, if so, who that designated beneficiary is. The RMD regulations provide detailed rules for how and when a designated beneficiary is determined. 1. Identifying the Designated Beneficiary. A designated beneficiary is an individual who is designated as a beneficiary under the plan or IRA. See Treas. Reg (a)(9)-4, Q&A- 1. a. A beneficiary may be designated under a plan or IRA in one of two ways. i. An individual may be designated as a beneficiary by the terms of the plan or IRA (e.g., a default designation). ii. An individual may be designated as a beneficiary by an affirmative election of the employee or IRA owner (e.g., on

9 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 8 a beneficiary designation form), assuming the plan or IRA permits elective beneficiary designations. b. A designated beneficiary need not be specified by name, so long as the individual who is designated as the beneficiary is identifiable under the plan or IRA. c. The designated beneficiary may be a class of beneficiaries capable of expansion or contraction (e.g., my children living at the time of my death ), and the class will be treated as identifiable if it is possible to identify the class member with the shortest life expectancy. d. An individual is not a designated beneficiary for RMD purposes merely because the individual would acquire the employee s or IRA owner s interest in the plan or IRA by will or operation of law upon the employee s or IRA owner s death. The individual must be designated as a beneficiary under the plan or IRA. 2. Designated Beneficiary Must be an Individual. In general, only individuals may be designated beneficiaries for RMD purposes. See Treas. Reg (a)(9)-4, Q&A-3. a. If a person or entity that is not an individual (e.g., an estate) is named as a beneficiary, the employee or IRA owner will be treated as not having a designated beneficiary for RMD purposes. b. If both an individual and a non-individual are named as beneficiaries, the employee or IRA owner will be treated as not having a designated beneficiary for RMD purposes, even though one beneficiary is an individual. c. An exception to the general rule may apply in the case of trusts named as beneficiaries. If certain requirements are met, the individual beneficiaries of the trust will be treated as the beneficiaries of the plan or IRA interest for purposes of determining whether there is a designated beneficiary. (See Part IV.E. of this outline for a more detailed discussion of the issues associated with naming a trust as the beneficiary of a plan or IRA interest.)

10 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 9 3. Time for Identifying the Designated Beneficiary. E. Some Special Rules. To be a designated beneficiary for RMD purposes, an individual must be a beneficiary as of the date of the employee s or IRA owner s death. See Treas. Reg (a)(9)-4, Q&A-4. However, the designated beneficiary is not determined for RMD purposes until September 30 of the year following the year of the employee s or IRA owner s death. a. Any person that was a beneficiary as of the time of death but does not continue to be a beneficiary as of September 30 of the year following the year of death (e.g., because the person s entire interest has been distributed before such date) is not treated as a designated beneficiary. This allows some opportunity to fix beneficiary designation problems, such as by distributing a beneficiary s entire interest or by having the beneficiary disclaim the beneficiary s interest. (See Part IV.D. of this outline for a more detailed discussion of the use of disclaimers in post-death RMD planning.) b. If the sole designated beneficiary of an employee or IRA owner as of September 30 of the year following such person s death is the person s surviving spouse but the surviving spouse dies before RMDs are required to begin, the beneficiary designation rules are applied as if the spouse was the employee or IRA owner. Thus, the designated beneficiary(ies) will be the individual(s) who are beneficiaries of the spouse as of the date of the spouse s death and continue to be beneficiaries as of September 30 of the year after the spouse s death. See Treas. Reg (a)(9)-4, Q&A-4(b). 1. Separate Accounts. If an employee s or IRA owner s interest under a plan or IRA is divided into separate accounts and the beneficiaries of each separate account are different, the separate accounts may be segregated and treated separately for RMD purposes in years after the separate accounts are established. See Treas. Reg (a)(9)-8, Q&A-2(a)(2). This may permit each beneficiary to use the beneficiary s own life expectancy for purposes of applying the RMD rules.

11 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 10 a. Deadline for Establishing Separate Accounts. In order to use separate distribution periods for each separate account established under a plan or IRA, the separate accounts must be established no later than the last day of the calendar year following the year of the employee s or IRA owner s death. b. Separate Account Rule Does Not Apply to Trusts. As noted above, if certain conditions are met, the individual beneficiaries of a trust named as the beneficiary of a plan or IRA may be treated as the designated beneficiaries of the plan or IRA for RMD purposes. This may permit RMDs to be determined using a life-expectancy rule rather than the 5-year rule. However, the separate account rules are not available to the individual beneficiaries of the trust in that case. See Treas. Reg (a)(9)-4, Q&A-5(c). Thus, the individual beneficiaries are not permitted separate distribution periods with respect to their separate shares under the trust. c. What Are Separate Accounts? Separate accounts under a plan or IRA are separate portions of the plan or IRA interest reflecting the separate interests of the beneficiaries as of the date of the employee s or IRA owner s death and for which separate accounting is maintained. The separate accounting must allocate all post-death investment gains and losses, contributions, and forfeitures, for the period prior to the establishment of the separate accounts on a pro rata basis in a reasonable and consistent manner among the separate accounts. However, once the separate accounts are actually established, the separate accounting can provide for separate investments for each separate account under which gains and losses from the investment of the account are only allocated to that account. A separate accounting must allocate any post-death distribution to the separate account of the beneficiary receiving that distribution. See Treas. Reg (a)(9)-8, Q&A Multiple Plans or IRAs. If an individual has an interest in multiple plans or IRAs subject to the RMD rules, the question arises whether the plans or IRAs may be aggregated for purposes of satisfying the RMD requirements (e.g., to

12 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 11 allow distribution of the entire RMD for all plans or IRAs from a single plan or IRA). a. Qualified Plans. b. IRAs. In the case of accounts under multiple plans in which an employee is a participant, the plans are not permitted to be aggregated for purposes of satisfying the RMD requirements. Rather the RMD requirements must be satisfied separately with respect to each plan. See Treas. Reg (a)(9)-8, Q&A-1. With respect to IRAs, the amount of the RMD must be calculated separately for each IRA. However, the separately calculated amounts may then be totaled, and the total distribution taken from any one or more of the individual s IRAs (other than Roth IRAs). See Treas. Reg , Q&A-9. c. 403(b) Annuities. Rules similar to the aggregation rules applicable to IRAs apply to 403(b) annuity contracts as well. Thus, if an individual has multiple annuity contracts, the RMD must be calculated separately for each contract, but the separately calculated amounts may then be totaled and the total distribution taken from any one or more of the individual s contracts. See Treas. Reg (b)-3, Q&A-4. However, only contracts an individual holds as an employee may be aggregated, and distributions from a 403(b) contract do not satisfy the RMD requirements with respect to IRAs held by the same individual (and vice versa) Required Minimum Distributions. The Worker, Retiree, and Employer Recovery Act of 2008 (WRERA) added Code Section 401(a)(9)(H), suspending the obligation to distribute RMDs for The suspension applied to all RMDs attributable to 2009, but not RMDs attributable to earlier or later years. For example, an individual who reached her required beginning date in 2008 but was not required to take her first RMD until April 1, 2009 was not affected by the suspension with respect to her first RMD, because the RMD related to 2008 even though it was payable in But an individual who reached her required beginning date in 2009 but was not otherwise required to take her first RMD until April 1, 2010 was eligible to suspend her first RMD

13 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 12 because it related to For additional guidance on the treatment of 2009 suspended RMDs, see IRS Notice IV. THE NON-SPOUSE BENEFICIARY ROLLOVER RULE. A. The Problem. The RMD rules under Code Section 401(a)(9) allow non-spouse beneficiaries some ability to stretch out the distribution period following the death of the employee or IRA owner. The rules for non-spouse beneficiaries generally are not as favorable as those for spouses. But, for example, in the case of an employee or IRA owner dying before her RMDs commence, payments to a non-spouse beneficiary typically may be taken over the life expectancy of the beneficiary. The problem in this respect is that qualified retirement plans are not required to offer distribution or withdrawal options that allow participants or beneficiaries to maximize the opportunity for deferral provided under the RMD rules. For example, a qualified retirement plan may only offer a lump-sum distribution option, rather than allowing for installment payments over the payee s life expectancy. This problem can be worked around in the case of the participant or the participant s surviving spouse. The rollover distribution rules allow those persons to rollover most or all of a lump-sum distribution from a qualified plan to an IRA. The IRA can then be used to maximize the distribution deferral period under the RMD rules. But before the Pension Protection Act of 2006 this was not an option for nonspouse beneficiaries. They were not eligible to roll distributions received in a beneficiary capacity from a qualified retirement plan to an IRA. So in a plan that offered only lump-sum distributions, they had no option but to take a distribution of the entire account balance and pay tax on it in the year of distribution. B. The Pension Protection Act of 2006 (PPA). The PPA added Code Section 402(c)(11), which specifically allows non-spouse designated beneficiaries to roll over distributions from qualified retirement plans to an IRA. The rollover options are still more limited than they are for a participant or spouse. For example, participants and spouses may direct a rollover distribution to another qualified retirement plan. But the non-spouse beneficiary rollover rule at least provides a means for non-spouse beneficiaries to maximize the tax deferral permitted under the RMD rules.

14 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 13 To qualify for treatment under this rule two key conditions must be satisfied: (1) the rollover distribution must be a direct rollover; and (2) the IRA to which the distribution is paid must be an inherited IRA within the meaning of Code Section 408(d)(3)(C). This means, among other things, that rollover treatment is not available where a non-spouse beneficiary personally receives a distribution and then deposits the funds in an IRA within 60 days. It must be a direct rollover. C. Inherited IRA. Under Code Section 408(d)(3)(C), an IRA generally is an inherited IRA if it was acquired by a non-spouse beneficiary by reason of the death of the account holder. Distributions from inherited IRAs are not eligible for rollover to another IRA or eligible retirement plan. Obviously, in the case of a distribution to a non-spouse beneficiary from a qualified retirement plan that is rolled directly to an IRA, the IRA itself is not inherited by reason of the death of the participant. The key is that the financial institution that maintains the IRA must treat it the same way that it treats IRAs inherited by non-spouse beneficiaries. D. Example. George is a participant in a qualified retirement plan sponsored by his employer. His account balance is $750,000. He is divorced but has two children, John and Alice. He names the children as his designated beneficiaries, each to receive 50% of his account balance in the event of his death prior to taking a distribution of his entire account balance. The plan only allows lump-sum distributions. George dies at age 63, while still employed. John and Alice are ages 35 and 31, respectively, at the time of George s death. Both have substantial other assets available to them and do not require immediate access to the funds in George s retirement account. In reliance on the non-spouse beneficiary rollover rule, John and Alice may elect to take lump-sum distributions of their 50% shares of the account balance in the form of direct rollover distributions to inherited IRAs established in their names at the financial institutions of their choice. This will allow them to take minimum distributions from the IRAs over the course of their respective life expectancies (30 plus years each), paying tax on the funds only as and when distributed. Without the non-spouse beneficiary rollover rule, John and Alice would have had no choice but to take immediately taxable lump-sum distributions of their respective shares of the retirement account after George s death, even though they did not require immediate access to the money. They could not have simply left

15 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 14 the funds in the qualified retirement plan because the plan terms would require distribution to be made no later than the end of the calendar year in which the fifth anniversary of the participant s death occurs, and perhaps sooner. V. MISCELLANEOUS A. Comparison of IRAs and Qualified Retirement Plans. The RMD rules generally apply the same in the context of IRAs and qualified retirement plans. But there are some subtle differences to keep in mind. 1. Roth IRAs v. Roth 401(k) Accounts. Roth IRAs are not subject to RMDs during the lifetime of the account owner. But there is no exception in the general RMD rules applicable to qualified retirement plans for Roth 401(k) accounts. So funds held in a Roth 401(k) account are subject to minimum distributions, if they remain in the plan at or after the participant s required beginning date. This difference typically can be worked around by taking a distribution of the Roth 401(k) account and rolling it to a Roth IRA. But it should not be assumed that distribution of Roth 401(k) funds may be deferred indefinitely within the qualified retirement plan. 2. Required Beginning Date. The required beginning date for a participant in a qualified retirement plan who does not own 5% or more of the employer is the later of (1) age 70-1/2, or (2) the participant s termination of employment. So a plan participant can defer distributions beyond age 70-1/2 if he or she continues to work. The rule for IRAs is more restrictive. The required beginning date for an IRA owner is age 70-1/2 in all cases. 3. Account Aggregation. If an individual holds multiple IRAs, he or she may aggregate those accounts for purposes of calculating the RMD due for a year and may then take that RMD from one of the IRAs. In other words, it is not necessary to take a distribution from each account each year, so long as the total of all distributions for a year equals or exceeds the amount that is required to be withdrawn from each account that year. This aggregation rule does not apply to qualified retirement plans. If an individual remains a participant in multiple qualified retirement plans past the individual s required beginning date, a minimum distribution must be taken from each qualified retirement plan in which the individual is a participant.

16 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page Plans May Limit Distribution Options. As described in connection with the non-spouse beneficiary rollover rule, qualified retirement plans are not obligated to offer a distribution option that allows participants to maximize the deferral opportunity provided by the RMD rules. So even though a participant who has reached his or her required beginning date may be able, under the RMD rules, to stretch distribution of the account over his or her remaining life expectancy, the participant may not be able to do that if the plan does not offer a distribution option that will accommodate RMDs. Many defined contribution plans, for example, allow only for lump-sum distributions. Note. If the participant has had a distributable event, this difference can be worked around by taking a distribution from the qualified retirement plan and rolling it over to an IRA. Most IRAs permit minimum withdrawals each year. B. RMDs May Not Be Rolled Over. RMDs from an IRA or qualified retirement plan are not eligible to be rolled over to another IRA or qualified retirement plan. An RMD is not an eligible rollover distribution. Code Section 402(c)(4)(B). This can present a trap for the unwary in any case where an individual may be receiving a distribution that is partially an RMD and partially an eligible rollover distribution. For example, in the event of the death of an IRA owner or qualified plan participant after he or she has reached his or her required beginning date, an RMD for the year of death must be made to the decedent s beneficiary, if the RMD has not been taken prior to the time of death. The beneficiary may also be claiming a distribution of the remaining account balance by reason of death and planning to roll that distribution to another eligible retirement plan. Care must be taken to segregate the remaining RMD for the year of death from the balance of the account. VI. RMD EXAMPLES. A. Naming the Surviving Spouse as Designated Beneficiary. 1. Why? Naming an employee s or IRA owner s surviving spouse as the designated beneficiary (rather than another individual or entity) can yield several benefits for RMD purposes.

17 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page How? a. It may permit the employee or IRA owner to elect a longer payment period if payments commence during the individual s lifetime. b. It may permit the surviving spouse to delay commencement of payments after the employee s or IRA owner s death. c. It may permit the surviving spouse to receive payment over a longer period after the employee s or IRA owner s death. Designation of the surviving spouse as beneficiary under a plan, account, or contract generally is accomplished by designating the spouse individually as the beneficiary on a form provided by the plan administrator or IRA or annuity provider. a. Cannot Designate a Trust. Designating a trust of which the surviving spouse is the sole beneficiary is not the same as designating the surviving spouse individually as the beneficiary. b. Designation by Default. In certain cases, the failure to designate any beneficiary may result in the surviving spouse being designated as the beneficiary by default. The terms of the applicable employer plan or IRA document or contract may provide that if no beneficiary is designated, the employee or IRA owner is deemed to have designated his or her surviving spouse. The RMD regulations treat a beneficiary designated under the terms of a plan or contract as the designated beneficiary for RMD purposes. See Treas. Reg (a)(9)-4, Q&A-1 & 2. Although this approach is not recommended for pre-death planning, it can provide a favorable result if the issue of RMDs is not addressed until after the death of the employee or IRA owner.

18 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page What Effect? Naming an employee s or IRA owner s spouse as the designated beneficiary can have consequences both during the employee s or IRA owner s life and after his or her death. a. Distributions Commencing During Lifetime. As noted above, distributions commencing during a payee s lifetime generally must occur over a period not longer than the period determined under the Uniform Lifetime Table provided in the regulations. However, if the payee s sole designated beneficiary is the payee s spouse, distributions may be made over the longer of the period determined under the Uniform Lifetime Table or the period determined under the Joint and Last Survivor Table. If the payee s spouse is significantly younger than the payee, this rule may permit longer deferral of the amounts held in the plan or account. b. Distributions Commencing After Death. Where distributions have not commenced at the time of the employee s or IRA owner s death, distributions generally must commence on or before the end of the calendar year immediately following the calendar year in which the employee or IRA owner died. However, if the employee s or IRA owner s sole designated beneficiary is his or her surviving spouse, distributions are not required to commence until the later of: i. The end of the calendar year immediately following the calendar year in which the employee or IRA owner died; or ii. The end of the calendar year in which the employee or IRA owner would have attained age 70½. If, for example, the employee or IRA owner suffers an untimely death, this rule can permit significant deferral of the required commencement of distributions, as compared to the result where a non-spouse beneficiary is named. c. Election to Treat IRA as Surviving Spouse s Own IRA. In the case of an IRA, the surviving spouse of the IRA owner may elect to treat the spouse s entire interest as a beneficiary in the IRA

19 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 18 as the spouse s own IRA. See Treas. Reg , Q&A-5(a). The election may be made any time after the death of the IRA owner. However, the spouse must be the sole beneficiary of the IRA and must have an unlimited right to withdraw amounts from the IRA. If the election is made, RMDs are thereafter determined as if the surviving spouse were the IRA owner rather than the IRA beneficiary. This rule may permit significant deferral of the commencement date and payment period, especially if the surviving spouse is significantly younger than the decedent. B. Making a QTIP Election for a Plan or IRA Interest. 1. Why? 2. How? If a surviving spouse is named as a beneficiary of a decedent s interest in a qualified plan or IRA (or a trust to which distributions from a plan or IRA are payable) but the spouse s interest is terminable (e.g., is only a life estate), the value of the interest will not qualify for the estate tax marital deduction unless the executor elects to treat the interest as qualified terminable interest property. In general, a QTIP election may be made with respect to property only if all the income from the property is payable to the surviving spouse annually. This requirement may conflict with the desire to receive only required minimum distributions from the qualified plan or IRA if the RMDs constitute less than all of the income generated by the asset each year. For estate tax purposes, a QTIP election is made on the estate tax return and must be made not later than the due date for the return (including extensions). However, to treat an interest in a qualified plan or IRA (or a trust to which distributions from a plan or IRA are payable) as eligible for a QTIP election, care must be taken in selecting a distribution option to ensure the requirement to receive all the income at least annually is satisfied. a. Outright Interest in Plan or IRA. Where a surviving spouse is named individually as a beneficiary of a qualified plan or IRA but with a terminable interest, simply receiving RMDs from the plan or IRA may not satisfy the QTIP requirements. Rather, a distribution option would have to be selected that would require distribution of all the income each year to the surviving spouse (or would permit the spouse to compel

20 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 19 distribution of all income each year). There are several issues that arise in these cases, including the following. i. What constitutes income for plan purposes may not be the same as income for QTIP purposes. ii. The plan or IRA may not provide for a distribution option that would automatically satisfy the QTIP requirements. Fortunately, the cases in which these issues arise (i.e., cases in which the spouse is designated as an outright beneficiary but with a terminable interest) will be relatively rare. Any such cases should be carefully evaluated on their individual facts. b. Interest in Trust Named as Beneficiary of Plan or IRA. 3. What Effect? A more likely scenario is one in which a surviving spouse is the beneficiary of a trust that is named as the beneficiary of a qualified plan or IRA. Here, we have some specific guidance from the IRS on the relationship between the QTIP requirements and the RMD requirements. In Revenue Ruling , C.B. 305, the IRS ruled that both a trust and an interest in an IRA of which the trust was a beneficiary constituted property eligible for a QTIP election. The trust gave the surviving spouse the power to compel the trustee to withdraw from the IRA an amount equal to all the income earned on the assets held in the IRA and pay that amount to the surviving spouse. If the surviving spouse exercised this power, the trustee was required to withdraw from the IRA the greater of the amount of income earned on the IRA assets during the year or the annual RMD. Nothing in the IRA instrument prohibited the trustee from withdrawing such amount from the IRA. If the surviving spouse did not exercise the power to compel a large withdrawal from the IRA, the trustee was required to withdraw only the annual RMD. Thus, the property qualified under the QTIP rules because the surviving spouse had the power to receive all income annually, but the trust preserved the flexibility to maximize deferral of the income tax on the IRA by allowing the surviving spouse to actually require withdrawal of only the RMD amount each year. If a timely QTIP election is made for a surviving spouse s interest in a

21 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 20 qualified plan or IRA (or a trust designated as the beneficiary of a qualified plan or IRA), the value of such property should qualify for the estate tax marital deduction. In the case of a trust satisfying the requirements of Revenue Ruling , this favorable result for estate tax purposes may be available while still limiting taxable distributions from the plan or IRA to the minimum amount required under the RMD rules. C. Using the Separate-Share Rule To Maximize Post-Death Deferral. 1. Why? 2. How? If distributions under a plan or IRA have commenced before the payee s death, payments after death generally must be made over a period not longer than the longer of (i) the remaining life expectancy of the payee, or (ii) the remaining life expectancy of the designated beneficiary. If distributions under a plan or IRA have not commenced before the payee s death, payments after death generally must be made over a period not longer than the life expectancy of the designated beneficiary. In either case, if there is more than one designated beneficiary, the shortest life expectancy of all designated beneficiaries generally must be used. In addition, if one of the designated beneficiaries is the surviving spouse, the special rules that apply to a surviving spouse s interest generally are inapplicable. However, under the separate account rule, if the interest under the plan or IRA may be divided into separate accounts with respect to each beneficiary, the distribution requirements for each such separate account may be determined without regard to the distribution requirements applicable to the other separate accounts. See Treas. Reg (a)(9)-8, Q&A-2. To apply the separate account rule, the relevant plan document or IRA document must be consulted to determine whether it provides for separate accounting. (Most standard IRA documents do. Other plan documents may vary.) If the document permits separate accounting, the separate accounts must be established not later than the last day of the year following the calendar year of employee s or IRA owner s death. See Treas. Reg (a)(9)-8, Q&A-2(a)(2). 3. What Effect? If benefits under a plan or IRA are timely divided into separate accounts, each of which has a different beneficiary, for years after the year in which the separate accounts are established, the separate accounts are viewed

22 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 21 separately for purposes of applying the RMD rules. See Treas. Reg (a)(9)-8, Q&A-2(a)(2). Thus, for example, if one separate account is established for a surviving spouse and another account is established for a non-spouse beneficiary, distributions from the separate account for the surviving spouse are not required to begin until the year in which the decedent would have reached age 70½, even though distributions from the separate account for the non-spouse beneficiary are required to begin earlier. D. Using a Disclaimer to Fix Designation Problems Post-Death. 1. Why? 2. How? Occasionally the beneficiary or beneficiaries designated or deemed designated under a plan or IRA do not permit the most tax-efficient distribution of benefits from the plan or IRA under the RMD rules. For example, both a surviving spouse and a non-spouse beneficiary might be named on the beneficiary designation form, but the facts may be such that significant tax deferral could be achieved if the surviving spouse was the sole beneficiary of the interest in the plan or IRA. Upon review after death, it may be determined that tax efficiency could be improved if one or more beneficiaries (e.g., the non-spouse beneficiary) was removed (voluntarily) from the picture, perhaps in exchange for an interest in other property of the decedent. In some cases, this may be accomplished by qualified disclaimer under Section 2518 of the Code. A qualified disclaimer is accomplished by delivering to the transferor (or the transferor s personal representative) a written refusal to accept the benefit of the transfer. See I.R.C. 2518(b). (Under Kansas law a disclaimer is made by filing a written instrument with the district court that describes the interest subject to the disclaimer, contains a declaration of disclaimer, and is signed and acknowledged by the disclaimant. See K.S.A , ) The disclaimer generally must be made within 9 months after the decedent s death, and the disclaimant must not have received any benefit from the disclaimed interest. Thus, any postdeath planning involving disclaimers must be addressed fairly soon after the decedent s death. 3. What Effect? Upon a disclaimer, the disclaimant generally is treated as having predeceased the decedent, and the disclaimed interest is treated as never

23 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 22 having passed to the disclaimant. See I.R.C. 2518(a); K.S.A Under the RMD rules, the designated beneficiary for RMD purposes is determined based on the beneficiaries designated as of the date of death who remain beneficiaries as of September 30 of the calendar year following the calendar year of the decedent s death. See Treas. Reg (a)(9)-4, Q&A-4. Thus, if an interest in a plan or IRA is disclaimed in a qualified disclaimer, the disclaimant will not be a beneficiary of the plan or IRA as of September 30 of the calendar year following the calendar year of the decedent s death, and the beneficiary of the interest will be determined either by reference to the remaining primary or contingent beneficiaries set forth on the beneficiary designation form or under the default provisions contained in the plan or IRA document. E. Naming a Trust as a Beneficiary. 1. Why? 2. How? Some employees or IRA owners may wish to name a trust as the beneficiary of their interest in the plan or IRA. Common reasons might include the following. a. Exercise control over distribution of, or access to, funds held in plan or IRA by placing control in hands of a trustee rather than the individual beneficiary(ies). b. Protect funds from claims of beneficiary s creditors. Note. Amounts held in a qualified plan or IRA generally are exempt from creditor claims until they are distributed. Naming a trust can further protect amounts once withdrawn or distributed. c. Avoid having to change the beneficiary designation form if the class or identity of the beneficiaries changes (i.e., can change underlying trust document without having to change beneficiary designation form). Mechanically, naming a trust as a beneficiary is as simple as naming the trustee of the trust as the beneficiary on the beneficiary designation form. (Note that the trustee must be named in the trustee s capacity as such.) But recall the general rule that only individuals can be designated beneficiaries of a plan or IRA for RMD purposes. How can an employee

24 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 23 or IRA owner name a trust as a beneficiary with confidence that the designation will be respected for RMD purposes? The RMD regulations specifically contemplate naming a trust as a beneficiary and provide that the beneficiaries of the trust will be treated as the designated beneficiaries for RMD purposes, so long as four requirements are satisfied. See Treas. Reg (a)(9)-4, Q&A-5. a. Valid Trust. The trust is valid under state law, or would be but for the fact that there is no corpus. b. Irrevocable. The trust is irrevocable or will, by its terms, become irrevocable upon the death of the employee. c. Identifiable Beneficiaries. The beneficiaries of the trust with respect to the trust s interest in the plan or IRA are identifiable from the trust instrument. d. Documentation. Certain documentation is provided to the plan administrator or IRA provider. This requirement may be satisfied in two ways: i. Provide a final list of all beneficiaries as of September 30 of the calendar year following the decedent s death, certify that the list is correct, and agree to provide a copy of the trust instrument upon request. ii. Provide a copy of the trust instrument. 3. What Effect? If the requirements described above are satisfied, the beneficiaries of the trust are treated as the designated beneficiaries of the plan or IRA for RMD purposes. If all of the beneficiaries are individuals, this means the beneficiaries generally may use the life expectancy of the oldest beneficiary for the RMD payment period, which can be a significant improvement over the result where the plan or IRA is treated as having no designated beneficiary. Note, however, a couple of important exceptions.

25 Key Concepts for Required Minimum Distributions from IRAs and Qualified Retirement Plans Page 24 a. No Separate Account Rule. Even though the individual beneficiaries are treated as the designated beneficiaries of the plan or IRA, the separate account rule described above is not available. See Treas. Reg (a)(9)-4, Q&A-5(c). Thus, even if the plan or IRA provides for establishing separate accounts, the beneficiaries may not establish separate accounts and use their own life expectancies for determining RMDs. b. Watch for Any Non-Individual Beneficiaries. Forgetting the trust for a moment, if an employee or IRA owner has one or more beneficiaries that are not individuals, the employee or IRA owner is treated as not having a designated beneficiary, even if there are other individual beneficiaries. See Treas. Reg (a)(9)-4, Q&A-3. The same rule applies when looking through a trust. See Treas. Reg (a)(9)-4, Q&A-5(c). Thus, if the trust has one or more non-individual beneficiaries, the look-through rules effectively no longer apply, and the employee or IRA owner is treated as not having a designated beneficiary. F. Naming a Charity or Charitable Remainder Trust as a Beneficiary. 1. Why? 2. How? Interests in qualified plans and IRAs carry a built-in income tax liability. Because they generally represent pre-tax contributions and earnings, every dollar distributed typically is taxable at ordinary income rates. This is the case even if distributions occur after the employee s or IRA owner s death. Distributions in that case are taxed as income in respect of a decedent (IRD). For this reason, qualified plan or IRA interests can be an attractive asset for satisfying charitable goals, because a tax-exempt charity (or charitable remainder trust) generally will not be required to recognize the built-in tax liability. Note. For estates with estate tax exposure, careful consideration must be given to the balance between income tax and estate tax issues, particularly as they relate to treatment of IRD items. As with a trust, the actual process of naming a charity or charitable remainder trust as a plan or IRA beneficiary is simple just name the