Article of
the week from Lawyers Weekly USA:
IRS Okays Huge IRA
Tax Savings
By James L. Dam
Money in IRAs and other retirement plans can be
withdrawn much more slowly in most cases, allowing for greater tax-free growth,
under new regulations proposed by the IRS.
This is an opportunity for tax savings that
lawyers will want to tell clients about, as well as take advantage of themselves, experts say.
The new rules "give attorneys and
clients a tremendous ability to defer income tax liabilities over an extended
period of time," says attorney Seymour Goldberg of Garden City, N.Y.,
author of Goldberg Reports, an online retirement planning newsletter.
Compared to the old rules for withdrawals,
they "are so much better, I can't believe it," says
Lawyers may want to notify clients who are
over 70 years of age or who have inherited a retirement account that they
should not make another withdrawal until they see how the new rules affect
them, says Choate.
The rules "are not getting as much
publicity as they might, so it might be worth writing to everybody," says
Michel Kaplan, an estate planning attorney in
The rules will not go into effect until
As to other types of retirement plans, such
as 401(k) and profit sharing plans, the rules can be used this year only if the
plan is amended by the end of the year.
The rules apply to both regular and Roth
IRAs, but they mostly affect regular IRAs, because withdrawals are not required
to be made from a Roth IRA until the account owner dies.
The new rules allow most account owners to
withdraw money more slowly while they are alive. For instance, an account owner
who is 75 years old and has named his or her 75-year-old spouse as the
beneficiary can take out 24 to 29 percent less this year. An 85-year-old whose
same-age spouse is the beneficiary can take out 30 to 49 percent less.
In many cases, the rules also allow
beneficiaries to withdraw money more slowly after the account owner has died.
They do this primarily by making it easier to have the withdrawals
"stretched" over the life expectancy of a young beneficiary.
For determining the amount that must be
withdrawn each year, the new rules are much simpler than the old rules, lawyers
agree. This will make it easier for account owners and beneficiaries to know
how much must be withdrawn.
However, the new rules also require IRA
providers to annually report to the IRS the minimum required withdrawal for
each account. As a result, there is likely to be much greater enforcement of the
rules, experts say.
In the past, "the IRS couldn't figure
out what the minimum amount was supposed to be," says Choate. "Nobody
could. It was too complicated."
"The IRS really had no idea," says
Barry Picker, a CPA in
"But now it's easy, so they will start
enforcing it," says Choate. "Now the IRS can just match up tax
returns with what is reported by providers."
The penalty for not withdrawing enough is a
50% excise tax on the additional amount that should have been withdrawn.
For estate planning attorneys, the new rules
make it somewhat easier to plan with clients' retirement accounts.
However, many problems remain, especially
with leaving a retirement account to a trust, lawyers agree.
These problems may actually be more common
and more difficult because retirement accounts will be larger than in the past,
as a result of clients withdrawing less under the new rules, says
A front-page article on the problems with
leaving IRAs to trusts appeared at 2000 LWUSA 729; Search words for LWUSA
Archives: Scream and Byzantine.
In addition, while the new rules resolve
some problems with the old rules, they also raise many new issues, say lawyers.
They "raise a whole host of additional
questions that didn't exist," says Jerold Horn of Peoria, Ill., a past
president of the American College of Trust and Estate Counsel.
"There are going to be a lot of
corrections," predicts Goldberg.
One critical issue is the extent to which
the rules are retroactive. For instance, in cases where an account owner died
years ago, it's not clear if the new rules would apply to the withdrawals the
beneficiaries make this year and in the future. Experts say that the rules
probably would not apply if the account owner died before the year 2000, but
this is not certain.
The rules replace proposed regulations that
were issued in 1987. The IRS is expected to issue final regulations by the end
of this year.
The new rules make five key changes:
1. The schedule for minimum withdrawals
during an account owner's life is the same for nearly everyone.
For calculating the minimum required amounts
that account owners must withdraw annually once they turn 701/2, there is now a
single schedule of life expectancies for nearly everyone.
To calculate the minimum withdrawal for a
year, account owners need only take their age on their birthday that year, look
at the schedule to find the life expectancy for that age, and divide the
balance of their account at the end of the previous year by that life
expectancy.
Example: In 2001, an account owner turns 73. According to the
schedule, his life expectancy is 23.5 years. Assume that his account balance at
the end of 2000 was $300,000. He would divide that figure by 23.5. The result,
$12,766, would be the minimum amount he must withdraw in 2001.
The only exception is that if the sole
beneficiary of an account is the account owner's spouse, and he or she is more
than 10 years younger than the account owner, then the minimum amount would be
based on the "joint" life expectancy of the account owner and the
spouse - which will result in even smaller required withdrawals than if the
account owner's life expectancy were used.
Under the old rules, determining the
required withdrawal was often much more complicated. It was generally based on
the "joint" life expectancy of the account owner and the oldest
beneficiary, and on which "method" was used for calculating each life
expectancy.
Just choosing which method or combination of
methods to use could be "a mind-boggling maze," says Robert Keebler, a CPA in
The beneficiary and "methods" had
to be chosen at age 701/2, and the choices made then, for purposes of
calculating the required withdrawals, were irreversible.
Also, under the old rules, the required
withdrawals were always as large and generally much
larger than under the new rules.
Required withdrawals were especially large
under the old rules if a beneficiary was a charity, because a charity was
treated as having a life expectancy of zero.
Under the new rules, there will not be this
drawback to naming a charity.
IRA owners can use the new rules for
calculating their required withdrawals for 2001. However, they probably cannot
use them for calculating a required withdrawal for 2000, even if the deadline
for that withdrawal is
2. After the account owner dies, the minimum
withdrawals are based on the life expectancy of the oldest named beneficiary on
Dec. 31 of the year following the owner's death.
Under the old rules, where the account owner
died after age 701/2, minimum required withdrawals were based on the life
expectancy of the oldest beneficiary the owner chose at age 701/2, and on the
owner's own life expectancy and choice of "methods."
If the owner later chose a younger
beneficiary, that would not matter.
Under the new rules, no choices have to be
made at age 701/2. Minimum withdrawals after the account owner dies are based
instead on the life expectancy of the oldest beneficiary of the account on Dec.
31 of the following year.
(Note: An exception under both the
new and the old rules is that if the account owner's spouse is a beneficiary,
he or she can "roll over" to his or her own IRA the account or
portion of it that he or she receives, and thereafter he or she will be treated
as the original owner of the funds and can name new beneficiaries.)
The change means that an account owner over
age 701/2 can replace an existing beneficiary with a younger one at any time,
and withdrawals after the owner dies can be based on that beneficiary's life
expectancy.
For example, if an account owner names his
wife as beneficiary, but she dies before he does, he can then name his child as
the beneficiary, and withdrawals after he dies can be based on the child's life
expectancy. The account is not "stuck" with the deceased wife's life
expectancy.
This solves a big problem, because people
frequently want to make their spouse the beneficiary, says Choate.
An account owner might also want to name a
younger beneficiary where an older beneficiary no longer needs the money.
For instance, the owner may decide that a
child no longer needs the money, and name a grandchild instead, says Steiner.
Also, many people at age 701/2 named their
estate as beneficiary, not realizing this prevents withdrawal calculations from
being based on any life expectancy other than their own. Under the new rules,
they can name a new beneficiary, and withdrawals after their death can be based
on that person's life expectancy.
Many other people name a trust as a
beneficiary but fail to comply with the complicated rules for doing so. Because
of this non-compliance, withdrawals after their death can be based only on
their own life expectancy. Under the new rules, if the trust is corrected,
withdrawals after death can be based on the life expectancy of a beneficiary of
the trust.
"People who loused up can fix and
repair all existing errors," says Goldberg. "There's a fresh
start."
Rather than replace an existing beneficiary,
an account owner might instead split an account up, so that only a portion of
it goes to a new beneficiary.
For instance, where a child is the
beneficiary of an account, the account owner might break one-third off into a
separate account and name a charity as the beneficiary. That way, the owner can
get the tax advantages of giving retirement benefits to charity, but the
two-thirds of the account that does not go to charity can still be withdrawn
based on the life expectancy of the child after the owner dies.
Under the old rules, this strategy would not
work if the account owner was over age 701/2.
The new rule - that
withdrawals after an account owner dies will be based on the life
expectancy of the oldest beneficiary of an account on Dec. 31 of the following
year - also means that the beneficiaries whose life expectancies will be used
can be changed even after an account owner dies.
"You can prune out undesirable
beneficiaries," says Choate.
This might be accomplished in three ways:
· By splitting an account into separate portions based on the percentages
going to the beneficiaries. For instance, if an account is going equally to a
parent and a child, it might be broken in two. That way, rather than both
portions being withdrawn over the life expectancy of the parent, the portion
going to the child could be withdrawn over the child's life expectancy.
· By having a beneficiary disclaim an account or portion
of one. For instance, if an account is going to a parent, where a child is the
contingent beneficiary and the parent doesn't need the money, he or she might
disclaim, allowing the account or a portion of it to go to the child instead.
Again, the portion going to the child could then be withdrawn over the child's
life expectancy.
· By distributing all of a beneficiary's portion of an
account to the beneficiary by the Dec. 31 deadline. For instance, if two-thirds
of an account is going to the children and one-third is going to a charity, the
charity's portion could be distributed by Dec. 31. That way, the charity's life
expectancy of zero would not be used for the children's portion of the account.
Such strategies can also be used in cases
where an account owner dies before age 701/2.
Because of the new rules, many account
owners may now want to change their beneficiaries.
In addition, it may be possible to
"change" the beneficiaries in cases where an account owner died in
2000 or 2001, since "December 31 of the year after the year the account
owner died" would occur in 2001, a year the IRS says is covered by the new
rules.
However, whether the new rules apply to such
cases is not certain.
"We are assuming they do, but it's not
entirely clear," says
Another thing that is unclear under the
rules is what life expectancy, if any, could be used if there is only one
beneficiary of an account, and the beneficiary dies before Dec. 31 of the year
after the year the account owner died.
That is "a big error in the
regulations, a big glitch," says Goldberg.
The IRS will probably fix this by saying
that the life expectancy the deceased beneficiary would have had on Dec. 31
will be used, says Choate.
3. If an account owner dies after age 701/2,
and there is a "non-human" beneficiary on Dec. 31 of the following
year, then withdrawals are based only on the account owner's life expectancy at
the time of death.
Again, under the old rules, where the
account owner died after age 701/2, minimum required withdrawals were based on
the life expectancy of the oldest beneficiary when the owner was age 701/2, and
on the owner's own life expectancy and choice of "methods."
If the "oldest" beneficiary when
the owner was 701/2 was the owner's estate, a charity or a trust that did not
comply with the trust rules, then only the owner's life expectancy would be
used. However, if the owner had chosen the "recalculation method," so
that his life expectancy was recalculated each year, his life expectancy would
drop to zero when he died.
The result would be that the entire account
would have to be paid out within a year after the owner's death.
Under the new rules, if the
"oldest" beneficiary on Dec. 31 of the year following the account
owner's death is his estate, a charity or non-complying trust, withdrawals can
still be spread over the owner's remaining "fixed term" life
expectancy, based the owner's age on his birthday the year he died.
Thus, it may be possible for the account to
be paid out more slowly.
In addition, it may also be possible to
avoid the problem under the new rules by changing beneficiaries, either while
the account owner is alive or in the year after his or her death.
4. If an account owner dies before age
701/2, and there is a "non-human" beneficiary on Dec. 31 of the
following year, then withdrawals must be completed in five years.
Under the old rules, if there was a
"non-human" beneficiary at the time the account owner died, the
"five-year rule" applied.
Under the new rules, "the five-year
rule" applies only if there is such a beneficiary on Dec. 31 of the year
following the account owner's death. This creates an opportunity - the one-year
period after death - to avoid the problem.
The "five-year rule" requires that
withdrawals be completed no later than Dec. 31 of the year that is the fifth
anniversary of the date of death.
5. Where the beneficiary is a trust,
documentation need not be filed when the account owner turns 701/2.
Under the old rules, if a trust was a
beneficiary, the IRA custodian or trustee had to be given a copy of the trust
or certain information about it when the account owner reached age 701/2, or if
owner died before then, within nine months after death.
Under the new rules, this documentation
generally need not be provided until Dec. 31 of the year following the year of
the account owner's death.
The only exception is where (1) the sole
beneficiary of the retirement account is a trust, (2) the sole beneficiary of
the trust is the account owner's spouse, and (3) he or she is more than 10
years younger than the account owner. In that case, this documentation is
necessary for the owner to use the spouse's life expectancy.
A public hearing on the new rules is
scheduled for
The rules were issued on
You can read, print or download the full
text of the rules in the "Important Documents" section of Lawyers
Weekly
www.lawyersweeklyusa.com/subscriber/treas.htm
Questions or comments can be directed to
the writer at: jdam@together.net