MILTON BERRY SCOTT
A Professional Corporation
Attorney at Law—California
Solicitor—England & Wales
1700 North Broadway, Suite 360
Walnut Creek, California 94596-4138
(925) 945-1480
Fax: (925) 945-8360
www.mbscott.com

Background

The Internal Revenue Service has finally issued final regulations in connections with naming of beneficiaries and required distributions from Individual Retirement Accounts. In 1987 the Internal Revenue Service issued proposed regulations on the naming of beneficiaries and the withdrawal from Individual Retirement Accounts. These proposed regulations, which were binding until final regulations were issued, were very complex and involved. In some cases, if a participant under a plan failed to take any action upon attaining age 70-1/2, then the participant was irrevocably bound by the default provisions of the plan and the then existing regulations. In some cases, where a participant died, the beneficiary or beneficiaries had to withdraw all of the plan assets, and pay income tax on them, within approximately a year from the date of the participant's death.

The regulations were very complicated, depending upon who was named as the beneficiary and the formula used to withdraw benefits.

On January 17, 2001, the Internal Revenue Service issued new proposed regulations, which greatly simplified the methods of withdrawing benefits from an IRA account as well as using longer life expectancy tables, permitting smaller withdrawals to be taken each year.

Changes

On April 17, 2002 the IRS issued final regulations which made limited changes in the proposed regulations issued in 2001. These new regulations made the following changes:

• Elimination of certain irrevocable elections.
• Use of uniform life expectancy tables.
• Use of newer updated life expectancy tables.
• Change of the date for determination of a designated beneficiary.
• Use of separate accounts for beneficiaries after participant's death.
• A number of other technical changes.

The new regulations are effective January 1, 2003. Plan sponsors such as banks, brokerage firms, savings banks, mutual funds, and others are required to amend their plans to incorporate all of the new changes into their IRA plans.

The required beginning date is the term used for the date in which a participant in an IRA account must start taking benefits from the IRA. Funds or assets in an IRA account can be withdrawn without a penalty only under certain circumstances; when a person becomes disabled, starts drawing benefits as an annuity prior to age 59-1/2, or attains age 59-1/2. Once a participant attains age 59-1/2, a participant can draw benefits in any amount without penalty.

When a participant attains age 70-1/2 that person must start drawing benefits or face a 50% penalty on what should have been withdrawn, but was not taken from the plan.

A person attains age 70-1/2 exactly six months after the person's 70th birthday. John Doe was born on June 12, 1935 and attains age 70 on June 12, 2005, and age 70-1/2 on December 12, 2005. The year 2005 is the first year that he has to make a withdrawal from the IRA plan.

The required beginning date for taking the first payment from an IRA plan is April 1st of the year following the year in which the participant attained age 70-1/2. In the above example, this would be April 1, 2006. If John Doe does not take a withdrawal in 2005, then he must take two payments in 2006, one for year 2005, and another for year 2006.

Distributions for all future years must be taken by December 31st of that year.

The required distributions which must start when a person attains age 70-1/2 must be either over the participant's life expectancy or over the joint life expectancy of the participant and a designated beneficiary. The IRS has developed a uniform table to be used where the participant's spouse is either the sole beneficiary or used if the sole beneficiary is not more than 10 years younger than the participant. If the spouse is named as the sole beneficiary and is not 10 years younger than the participant, the following tables can be used to determine the required amount of distribution each year. The age is based on the participant's and beneficiary's attained age on December 31st of each year.

The following table is used where there is a spouse or other beneficiary who is not more than 10 years younger than the participant.

The tables continue until age 115 or later.

If the beneficiary or the oldest beneficiary is more than 10 years younger than the participant, including the spouse if named, the minimum distribution is computed on their joint ages with a recalculation each year and this is covered by a separate table.

Annual required distribution

To determine the required amount a participant takes the fair market value of the plan as of December 31st and divides it by the divisor listed above.

Our John Doe attained age 70-1/2 on December 12, 2005. He must make a withdrawal for year 2005, although he can postpone taking the withdrawal until April 1, 2006. He takes the value of his IRA plan as of December 31st of the year prior to the year of withdrawal, or December 31, 2004. His IRA account was worth $1,000,000 on that date. John Doe was 70 years of age on December 31, 2005. He has named his wife as the sole beneficiary of his IRA account and she is not more than 10 years younger than he is. The divisor is therefore 27.4. Dividing $1,000,000 by 27.4 produces a required distribution of $36,496. This amount is the minimum which must be taken from the plan by April 1, 2006.

John Doe takes $36,496 by December 31, 2005. For 2006 he takes the fair market value of the plan on December 31, 2005, and divides it by his attained age on December 31, 2006, to determine the amount he has to withdraw in 2006. If the plan had grown and was worth $1,041,740 on December 31, 2005, and divided by 26.5 (divisor for age 71), then this would produce a required distribution by December 31, 2006 of $38,450.

Every year the person must determine the minimum which must be withdrawn that year, prior to December 31st. Amounts must be withdrawn by December 31st of the year except for the first year, when the participant attains age 70-1/2, where the participant can withdraw the required amount by April 1st of the following year.

A participant can always take a larger amount than the required minimum, but this does not reduce future withdrawals. If John Doe took $60,000 from his plan in 2005, he would still use the fair market value of the plan on December 31, 2005, and divide that by 26.5 to determine his minimum distribution for 2006.

Death of participant

In the year of death, the required withdrawal must still be taken. John Doe dies May 1, 2006. His withdrawal for 2006 should have been $38,450. His wife is the beneficiary of his plan. She must withdraw $38,450 by December 31, 2006, if her husband had not taken this amount prior to death. Payments for the years after death are determined differently, as shown below.

Younger beneficiary or no beneficiary

If the sole beneficiary of an IRA plan is more than 10 year younger than the participant then separate actuarial tables are used, which allow a smaller divisor and a longer payout period. When John Doe attains age 70, his wife is only age 55 (both ages are determined as of December 31st of the year in question). The divisor for two people, ages 70 and 55, is 35.6 instead of 27.4. The IRS has tables in the regulations showing the tables for two varying ages.

If there are several beneficiaries named, the age of the oldest beneficiary governs. If a charity, an estate, or a trust (unless the trust is a qualified trust) is named as the sole beneficiary, the age for any of these is zero, so the participant's age alone would govern.

Spouse as beneficiary at death at death

1. Rollover plan assets to a new IRA account in the spouse's name.
2. Defer the first year's required distribution until the participant would have attained age 70-1/2.
3. Defer distributions over the spouse's remaining recalculating single life expectancy.

Other individuals as beneficiaries

If plan assets divided by September 30th of the year after the year of death, beneficiaries may withdraw assets over their respective remaining non-recalculating single life expectancy.

Trust as beneficiary

1. The life expectancy of the oldest trust beneficiary is used, if all of the following conditions are met:
2. The trust is a valid trust under state law.
3. The trust became irrevocable upon the participant's death.
4. The trust beneficiaries are either named individually or are identifiable under the trust document.
5. A copy of the trust document is provided to the IRA custodian no later than October 31st of the year following the year of death.

Estates, non-qualifying trusts, and charities as beneficiaries

After required beginning date, over the participant's remaining non-recalculating life expectancy.

Before required beginning date, within five years-all assets must be distributed prior to December 31st of the fifth year following participant's death.