New Rules Simplify IRA Required Distributions

By Clifton Linton
Senior Writer, mPower

In This Story Who's Affected? The Changes Timing Is Everything Effective Now

New distribution rules just issued by the IRS are good news if you've got an IRA. It will be easier to name new beneficiaries and calculate required minimum distributions once you turn 70½, and your savings may last you longer in retirement.

IRA holders can start using the rules immediately, the IRS says. This will help retirees and workers who currently make withdrawals or who need to start this year.

minute: read this article at a glance.

Technical Terms Beneficiary Required beginning date Required minimum distribution (RMD) Tax deferral

The new rules became effective on Jan. 12, when the Clinton administration made a flurry of last-minute executive decisions and rule changes.

They make it less likely that someone will make a costly mistake when naming a beneficiary and deciding how to calculate minimum withdrawals from a retirement account. Previously, figuring out how to withdraw money without paying a bundle in taxes or unwittingly depleting an inheritance often required hiring a battery of lawyers, financial planners and accountants to interpret the IRS' arcane distribution rules.

Under the old rules, "there were many traps and many ways ... to get messed up" and lose more of the IRA to taxes than necessary, said Victor Finmann, a Mineola, N.Y. attorney specializing in estate planning. "They have removed the traps."

The IRS has "tried to simplify the rules and give (retirees) more flexibility," said Kyle Brown, retirement counsel with Watson Wyatt Worldwide.

Who's Affected?

The new rules do apply to IRA holders who are 70½ and must start taking required minimum distributions from their account, and they do apply to withdrawals by your beneficiaries if you die after age 70½.

They don't affect IRA withdrawals you make before age 70½, and they don't affect withdrawals by your beneficiaries if you die before 70½.

The Changes

In announcing its new rules, the IRS acknowledged that the old rules were "unreasonably restrictive" and "too complex."

"There was no reason for the rules to be as harsh as they were," Finmann said.

Under the old rules, you had to name your beneficiaries and select the way of calculating your required minimum distributions by the time you reached your required beginning date. Your required beginning date is April 1st of the year after you turn 70½. The decisions you made then were irrevocable, meaning they affected your withdrawals for the rest of your life.

The decisions could be simple if you were single and had no heirs. Yet, if you wanted to leave your nest egg to your children or a charity, it got complicated. If you made a bad choice, your heirs could be forced to withdraw the IRA balance all at once. This meant they had to pay income tax on the entire amount at once, plus the balance stopped growing tax-deferred.

The old withdrawal rules were "unreasonably restrictive" and "too complex." — Jan. 12, 2001 IRS statement.

Here are highlights of the new rules.

No More Irrevocable Decisions: Probably the most important change in the new rules is that you gain more flexibility about naming beneficiaries.

Under the old rules, the choices on record with your IRA custodian when you reached your required beginning date were irrevocable. That was a problem for many people who neglected to name a beneficiary — they were forced to go with the default beneficiary election contained in their IRA custodial agreement, Finnmann said. Those default elections were not always in the best interest of the account holder.

The new rules don't require you to name a beneficiary until you're ready.

"Now, you can change your mind on a regular basis," said Brown.

Here's why this is important. Suppose before reaching 70½ you selected your spouse as your beneficiary and decided to use their life expectancy to calculate your distributions. If you chose the wrong method of calculating your combined life expectancy and your spouse died first, you might have to increase the withdrawals from your IRA account and drain it faster. Under the old rules, your distributions would still be governed by a decision that you made earlier but was no longer valid.

Under the new rules, if your spouse dies first, you can choose a new beneficiary and use that person's life expectancy.

"No longer do we have the fears that the parents made a bum decision (after reaching the required beginning date)," said Certified Financial Planner George Coughlin, based in Walnut Creek, Calif.

Easier to Compute Withdrawals: Under the old rules, when you started taking withdrawals, you had to decide if you were going to use single or joint life expectancy. Combining two life expectancies could help you stretch out your withdrawals. The formula used to calculate two life expectancies factors in the fact that one person may outlive the other.

You also had to decide if you would use a term certain, re-calculation or hybrid method of calculating the withdrawals. Further, if you named a child 25 years younger than you as a beneficiary, you could not take full advantage of the age difference to stretch out the payments. The biggest difference you could use was 10 years.

Under the new rules, all you need to figure out is if you will be using a single life expectancy, yours, or a joint life expectancy, yours and your beneficiary's. But, be aware you can only use a joint life expectancy calculation if you name your spouse as sole beneficiary.

Here's how it works. Suppose you will turn age 70½ this year and will need to start taking minimum distributions in 2002. Further suppose you have an IRA balance worth $1 million. You can figure out your required distribution by looking at the IRS' new distribution table (page 52) and dividing the account balance by the "distribution period" on the table.

At age 70½, the distribution period is 26.2. Divide $1 million by 26.2 and you get $38,168, your required distribution.

"Now, you can change your mind on a regular basis." — Kyle Brown, retirement counsel with Watson Wyatt Worldwide.

If you wanted to stretch out the payments by using a joint life expectancy, the calculations are still fairly simple. You refer to the joint life expectancy tables in IRS Publication 590 (page 76).

Suppose your spouse is 55 and you are 70½. You would divide the balance by the joint life expectancy distribution period of 29.9, for a required distribution of $33,445.

If you inherit an IRA balance, you may also be able to use your remaining life expectancy to calculate your required withdrawals.

Money Can Last Longer: One of the key changes in the new rules is that the life expectancy tables are more generous. With a longer life expectancy, you may now take smaller withdrawals beginning at age 70½. That means money in your IRA could last longer and grow tax-deferred longer as well.

You Will Be Told How Much to Take: In addition to simplifying the calculations, the new rules require your IRA custodian to tell you how much you are required to withdraw.

"The person will not have to compute" the required distribution, Finmann said.

Of course, this also means that your custodian will have to report to the IRS the amount you are supposed to take. This will make it easier for the IRS to see if you are trying to avoid paying taxes by not withdrawing the required amount. The fine for failing to take a required distribution is 50 percent of the amount that should have been withdrawn.

Beneficiary Choices Can Be Altered After Death: Under the new rules, beneficiary designations don't have to be finalized until the end of the calendar year that follows the year of the account holder's death.

Suppose you named your son and daughter as beneficiaries. But, after you died, only your son really needed the money. Under the new rules, your daughter could disclaim her benefit. This would mean that your son could take all the money and base his withdrawals on his life expectancy. This flexibility wasn't permitted under the old rules.

This rule applies only to beneficiaries named before your death.

Timing Is Everything

Some of these changes had been talked about for a while, according to retirement industry experts. The only question was whether they would actually become law.

The timing of the release surprised the retirement industry because it happened in the waning days of the Clinton administration. Typically, last-minute rule revisions include provisions too controversial to release while the president has a substantial amount of time left in his term.

Still, Dallas Salisbury, president of the Employee Benefit Research Institute, criticized the government for surprising the industry with the new rules. "It's a classic example of the government not paying attention to the impact on the system."

For the most part, this set of rule revisions has received a favorable review and will probably stand, experts say.

Yet, the reporting requirement is likely to meet objections from the financial services industry, Brown said. While the firms may complain these rules will add to their administrative costs, however, they could be easily offset by the increased fees from clients who will now be able to leave money in their accounts longer.

Related Reading What You Need to Know about Naming a Beneficiary IRS Issues Simplified Rules for IRA, 401(k) Required Distributions, Beneficiaries

Effective Now

For IRA holders, the new regulations became effective the date they were distributed, Jan. 12, 2001. The rules apply even if your IRA custodian hasn't amended your custodial agreement. 

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

New Rules Simplify IRA Required Distributions

By Clifton Linton
Senior Writer, mPower

In This Story Who's Affected? The Changes Timing Is Everything Effective Now

New distribution rules just issued by the IRS are good news if you've got an IRA. It will be easier to name new beneficiaries and calculate required minimum distributions once you turn 70½, and your savings may last you longer in retirement.

IRA holders can start using the rules immediately, the IRS says. This will help retirees and workers who currently make withdrawals or who need to start this year.

minute: read this article at a glance.

Technical Terms Beneficiary Required beginning date Required minimum distribution (RMD) Tax deferral

The new rules became effective on Jan. 12, when the Clinton administration made a flurry of last-minute executive decisions and rule changes.

They make it less likely that someone will make a costly mistake when naming a beneficiary and deciding how to calculate minimum withdrawals from a retirement account. Previously, figuring out how to withdraw money without paying a bundle in taxes or unwittingly depleting an inheritance often required hiring a battery of lawyers, financial planners and accountants to interpret the IRS' arcane distribution rules.

Under the old rules, "there were many traps and many ways ... to get messed up" and lose more of the IRA to taxes than necessary, said Victor Finmann, a Mineola, N.Y. attorney specializing in estate planning. "They have removed the traps."

The IRS has "tried to simplify the rules and give (retirees) more flexibility," said Kyle Brown, retirement counsel with Watson Wyatt Worldwide.

Who's Affected?

The new rules do apply to IRA holders who are 70½ and must start taking required minimum distributions from their account, and they do apply to withdrawals by your beneficiaries if you die after age 70½.

They don't affect IRA withdrawals you make before age 70½, and they don't affect withdrawals by your beneficiaries if you die before 70½.

The Changes

In announcing its new rules, the IRS acknowledged that the old rules were "unreasonably restrictive" and "too complex."

"There was no reason for the rules to be as harsh as they were," Finmann said.

Under the old rules, you had to name your beneficiaries and select the way of calculating your required minimum distributions by the time you reached your required beginning date. Your required beginning date is April 1st of the year after you turn 70½. The decisions you made then were irrevocable, meaning they affected your withdrawals for the rest of your life.

The decisions could be simple if you were single and had no heirs. Yet, if you wanted to leave your nest egg to your children or a charity, it got complicated. If you made a bad choice, your heirs could be forced to withdraw the IRA balance all at once. This meant they had to pay income tax on the entire amount at once, plus the balance stopped growing tax-deferred.

The old withdrawal rules were "unreasonably restrictive" and "too complex." — Jan. 12, 2001 IRS statement.

Here are highlights of the new rules.

No More Irrevocable Decisions: Probably the most important change in the new rules is that you gain more flexibility about naming beneficiaries.

Under the old rules, the choices on record with your IRA custodian when you reached your required beginning date were irrevocable. That was a problem for many people who neglected to name a beneficiary — they were forced to go with the default beneficiary election contained in their IRA custodial agreement, Finnmann said. Those default elections were not always in the best interest of the account holder.

The new rules don't require you to name a beneficiary until you're ready.

"Now, you can change your mind on a regular basis," said Brown.

Here's why this is important. Suppose before reaching 70½ you selected your spouse as your beneficiary and decided to use their life expectancy to calculate your distributions. If you chose the wrong method of calculating your combined life expectancy and your spouse died first, you might have to increase the withdrawals from your IRA account and drain it faster. Under the old rules, your distributions would still be governed by a decision that you made earlier but was no longer valid.

Under the new rules, if your spouse dies first, you can choose a new beneficiary and use that person's life expectancy.

"No longer do we have the fears that the parents made a bum decision (after reaching the required beginning date)," said Certified Financial Planner George Coughlin, based in Walnut Creek, Calif.

Easier to Compute Withdrawals: Under the old rules, when you started taking withdrawals, you had to decide if you were going to use single or joint life expectancy. Combining two life expectancies could help you stretch out your withdrawals. The formula used to calculate two life expectancies factors in the fact that one person may outlive the other.

You also had to decide if you would use a term certain, re-calculation or hybrid method of calculating the withdrawals. Further, if you named a child 25 years younger than you as a beneficiary, you could not take full advantage of the age difference to stretch out the payments. The biggest difference you could use was 10 years.

Under the new rules, all you need to figure out is if you will be using a single life expectancy, yours, or a joint life expectancy, yours and your beneficiary's. But, be aware you can only use a joint life expectancy calculation if you name your spouse as sole beneficiary.

Here's how it works. Suppose you will turn age 70½ this year and will need to start taking minimum distributions in 2002. Further suppose you have an IRA balance worth $1 million. You can figure out your required distribution by looking at the IRS' new distribution table (page 52) and dividing the account balance by the "distribution period" on the table.

At age 70½, the distribution period is 26.2. Divide $1 million by 26.2 and you get $38,168, your required distribution.

"Now, you can change your mind on a regular basis." — Kyle Brown, retirement counsel with Watson Wyatt Worldwide.

If you wanted to stretch out the payments by using a joint life expectancy, the calculations are still fairly simple. You refer to the joint life expectancy tables in IRS Publication 590 (page 76).

Suppose your spouse is 55 and you are 70½. You would divide the balance by the joint life expectancy distribution period of 29.9, for a required distribution of $33,445.

If you inherit an IRA balance, you may also be able to use your remaining life expectancy to calculate your required withdrawals.

Money Can Last Longer: One of the key changes in the new rules is that the life expectancy tables are more generous. With a longer life expectancy, you may now take smaller withdrawals beginning at age 70½. That means money in your IRA could last longer and grow tax-deferred longer as well.

You Will Be Told How Much to Take: In addition to simplifying the calculations, the new rules require your IRA custodian to tell you how much you are required to withdraw.

"The person will not have to compute" the required distribution, Finmann said.

Of course, this also means that your custodian will have to report to the IRS the amount you are supposed to take. This will make it easier for the IRS to see if you are trying to avoid paying taxes by not withdrawing the required amount. The fine for failing to take a required distribution is 50 percent of the amount that should have been withdrawn.

Beneficiary Choices Can Be Altered After Death: Under the new rules, beneficiary designations don't have to be finalized until the end of the calendar year that follows the year of the account holder's death.

Suppose you named your son and daughter as beneficiaries. But, after you died, only your son really needed the money. Under the new rules, your daughter could disclaim her benefit. This would mean that your son could take all the money and base his withdrawals on his life expectancy. This flexibility wasn't permitted under the old rules.

This rule applies only to beneficiaries named before your death.

Timing Is Everything

Some of these changes had been talked about for a while, according to retirement industry experts. The only question was whether they would actually become law.

The timing of the release surprised the retirement industry because it happened in the waning days of the Clinton administration. Typically, last-minute rule revisions include provisions too controversial to release while the president has a substantial amount of time left in his term.

Still, Dallas Salisbury, president of the Employee Benefit Research Institute, criticized the government for surprising the industry with the new rules. "It's a classic example of the government not paying attention to the impact on the system."

For the most part, this set of rule revisions has received a favorable review and will probably stand, experts say.

Yet, the reporting requirement is likely to meet objections from the financial services industry, Brown said. While the firms may complain these rules will add to their administrative costs, however, they could be easily offset by the increased fees from clients who will now be able to leave money in their accounts longer.

Related Reading What You Need to Know about Naming a Beneficiary IRS Issues Simplified Rules for IRA, 401(k) Required Distributions, Beneficiaries

Effective Now

For IRA holders, the new regulations became effective the date they were distributed, Jan. 12, 2001. The rules apply even if your IRA custodian hasn't amended your custodial agreement. 

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.