New Rules Affect Required Minimum Distributions

The IRS recently issued proposed regulations making sweeping changes to the rules on minimum distributions from IRAs, 401(k)s, and most other qualified plans. Although the final regulations aren’t expected to take effect until 2002, the proposed regs say taxpayers can now use either the new rules or the old rules when computing minimum required distributions (RMDs) for 2001.

Most taxpayers will find that choice easy to make since the new rules are more generous. Calculating IRA withdrawals becomes simpler, RMDs are lowered in most cases, and taxpayers can change beneficiaries whenever and as often as they want. The old rules were complicated and resulted in many taxpayers locking into distribution methods that were unfavorable to them and their heirs. Once the distributions started, the formulas couldn’t be changed.

Although distribution rules have been simplified, the IRS has created a new reporting system for enforcing them. IRA providers, such as banks and brokerages, will have to report RMDs to the government and the taxpayer, as well as verify that the taxpayer took the distribution. Taxpayer errors will result in a 50 percent penalty.

The old regulations required account owners to lock in their annual minimum distributions by choosing a calculation method and a beneficiary by age 70-½. The new rules create a uniform table to determine RMDs based on the accountholder’s age and prior year-end balance. RMDs are generally computed without regard to the beneficiary’s age, although the proposed regs permit a longer payout period if the beneficiary is a spouse who is more than 10 years younger than the account holder. For account holders currently taking RMDs, the switch to the new tables could result in substantial savings since required distributions are usually smaller. The good news is that since the life-expectancy table has been lengthened, more money can continue to grow tax-deferred for those who don’t need it for living expenses.

The new rules also simplify inheritance issues, basing minimum distributions from inherited plans on the life expectancy of the beneficiary. The beneficiary designation isn’t finalized until December 31 of the year following death, instead of being locked in after the owner turns 70-½. This allows flexibility in changing plan beneficiaries up until death and even offers the possibility of posthumous planning.