by Joseph Hollak of Salomon Smith Barney

The Internal Revenue Service has done a complete about-face on the methods for calculating the Required Minimum Distributions (RMDs) from Individual Retirement Accounts.  After 13 years of trying to enforce the convoluted Required Minimum Distribution rules for IRAs, the IRS has wiped the slate clean with new proposed regulations that vastly simplify the calculation process. The previous RMD rules that tripped up many retirees and their heirs are simply—gone.

Consider these positive results of the new regulations:

(1) Annual Required Minimum Distributions, which are mandated after age 70½, are reduced in most cases.  This means more funds can remain tax-deferred in your IRA and less needs to be reported as taxable income.  This may have a positive ripple effect on the taxability of any Social Security benefits you are receiving, the phase out of personal exemptions, and on other tax issues.

(2) Beneficiary designations with regard to RMD calculation elections and the RMD calculation elections themselves are no longer irrevocable.

(3) Anyone inheriting an IRA can receive payments over his or her own life expectancy.

Required Minimum Distribution Calculations Are Now Simple

The new RMD calculation is much simpler than the past requirements that have been in effect since 1987. Under the new IRS rules, you no longer have to designate a beneficiary prior to taking your first required minimum distribution, and calculation terms such as the recalculation, term certain or hybrid methods are obsolete.  You need only to determine two numbers in order to calculate your required minimum distribution: the fair market value of your IRA as of the prior year-end and the life-expectancy factor associated with your age.  With very limited exceptions, all IRA owners over age 70½ will use the Uniform Life Expectancy Table (formerly called the MDIB Table) to determine their life expectancy factors. 

You Have Greater Flexibility to Change Your Beneficiaries

Under the old distribution regulations, you were “locked in” to your beneficiary designation for the purposes of taking RMDs.  Now, most beneficiary changes will have no impact on your RMD under the Uniform Life Expectancy Table.  Therefore, you may change beneficiaries whenever necessary.

The only time there will be an effect on your RMD is if you change your beneficiary to or from a spouse who is more than 10 years younger than you are.

? If you change to a spouse beneficiary who is more than 10 years younger than you, you will use the Joint Life Expectancy Table to calculate your distribution. This will reduce your RMD even more than if you used the Uniform Distribution Table life expectancy factors.

? If you change to a spouse beneficiary who is less than 10 years younger than you, you will refer to the Uniform Life Expectancy Table to determine your RMD.

Your Beneficiaries Have More Distribution Options

While spouse beneficiaries always had the option of continuing to use an IRA to shelter inherited IRA assets, non-spouse beneficiaries were more limited in their choices.  Under the new regulations, all your beneficiaries have the ability to keep the IRA assets they inherit in a tax-deferred IRA, thus spreading the taxable income from distributions over a greater number of years. In order to preserve the tax-deferred nature of inherited IRA assets, spousal beneficiaries can roll these assets into their own IRAs, while non-spouse beneficiaries will have to open beneficiary or conduit IRAs to receive these assets.  This feature can be especially attractive to younger non-spouse beneficiaries who are now able to calculate distributions based on their own life expectancies, which could extend the life of this IRA into their own retirement years. 

What You Should Do Now

Whether this is your first year to take an RMD, or if you have been taking distributions already under a now-obsolete calculation method, the new rules on IRA distributions are effective immediately.  IRA owners taking required minimum distributions for calendar year 2001 may calculate their distributions under these new rules.  Beneficiaries of inherited IRAs need to determine whether or not they are eligible for the new rules.  The final regulations will be made available in 2002, and the IRS has indicated that if the rules are more restrictive, they will not be retroactive to 2001 distributions.  IRA holders should review their primary and contingent beneficiary designations from time to time and make any changes that would reflect their current situation. Again, under the new rules, beneficiaries do not have an effect on distributions.  However, since distributions from an IRA are taxable, you should consult your tax advisor before making any distribution decisions.

Joseph Hollak is a fiancial consultant in the investment area for Salomon Smith Barney, 121 SW Morrison Street, 16th Floor, Portland, OR 97204. You may phone him at 503-221-6680   Salomon Smith Barney does not provide tax advice.  Please consult your tax advisor for such guidance.