Proposed Minimum Required Distribution Regulations Afford Charitable Gift Planning Opportunities

Proposed Minimum Required Distribution Regulations Afford Charitable Gift Planning Opportunities

Article posted in Regulations on 8 February 2001| comments
audience: National Publication | last updated: 16 September 2012
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Summary

On January 17, 2001, the Treasury published a third set of proposed regulations construing the "minimum required distribution" rules for qualified plans and IRAs under Code Section 401(a)(9). The "new" regulations represent a considerable simplification over the rules set forth in the proposed regulations first issued in 1987 and amended on December 30, 1997. This article provides an overview of the proposed regulations and identifies features that may afford charitable gift planning opportunities.

by Russell A. Willis III

On January 17, 2001, the Treasury published a third set of proposed regulations1 construing the "minimum required distribution" (MRD) rules for qualified plans and IRAs under IRC § 401(a)(9). The "new" regulations represent a considerable simplification over the rules set forth in the proposed regulations first issued in 1987 and amended on December 30, 1997.2 This article identifies those features of the "new" proposed regulations that may afford charitable gift planning opportunities.

Background

It is not possible under current law for donors to give their qualified retirement plans or IRA assets to charity during their lifetimes without first withdrawing the assets and subjecting them to income tax at the highest rates on ordinary income. Account owners under the age of 59½ are also subject to early withdrawal penalties if they wish to withdraw and give their qualified plan and IRA assets to charity. However, the charitable tax disincentives that come with these assets during the account owner's lifetime become far less costly at death, via testamentary dispositions of retirement plan and IRA assets to public charities or charitable remainder trusts (CRTs).

Any assets remaining in an IRA, 401(k), 403(b), ESOP, profit sharing, or money purchase pension plan account at the death of the owner are generally taxed to whomever is entitled to receive them as income in respect of a decedent (IRD) unless the recipient is the owner's surviving spouse who elects to take over the account and treat it as his or her own. At the death of the original account owner (or his or her surviving spouse, if any), a popular estate planning technique is to shelter this IRD from onerous taxation by either using it to fund the decedent's testamentary charitable bequests or a testamentary CRT for the benefit of the deceased owner's nonspousal heirs and favorite charities. This strategy offers both income and estate tax savings if properly implemented.

However, implementing this strategy with maximum benefits to the account owners and their heirs has been complicated by the rules that require minimum annual distributions to be made from qualified plan and IRA accounts to their owners who survive beyond age 70½. These very complex rules are designed to force money out of qualified plans and IRAs so that it can be taxed rather than allow it to be sheltered indefinitely inside a noncharitable, tax-exempt entity. Usually, to minimize the impact of these force-out provisions, planners have to rely on the anticipated use of timely disclaimers by heirs and other devices to fund charitable remainder trusts with IRD from qualified plans and IRAs.

Understanding of these minimum distributions rules thus becomes very important to donors and their charitable gift planners who wish to maximize the amount of qualified plan and IRA assets that will remain at the donor's death to fund testamentary charitable gifts or CRTs at the lowest possible tax cost and with maximum benefits to heirs.

Under the new proposed regulations, it remains the case that a participant in a qualified plan or the owner of an IRA is required to begin taking distributions from the plan or the account no later than April 1st of the year following the year in which age 70½ is attained. This is statutory.3 But the entire regime, as set forth in the earlier proposed regulations in 1987 and 1997, of properly identifying a qualified "designated beneficiary" (DB) on, or before, the "required beginning date" (RBD), electing to calculate "minimum required distributions" either on the projected life expectancy of the participant alone, or on the joint life expectancies of the participant and the DB, with or without "recalculation" annually of one, or both, lives is no longer applicable (or will be, when and if, the proposed regulations take effect).

The New Proposed MRD Rules

Under the new proposed regulations, the MRD is to be calculated with respect to every participant as though he or she had identified a qualified DB who is exactly 10 years younger than the participant (there is an exception for a participant who has, in fact, designated a spouse who is more than 10 years younger), and had elected to recalculate both life expectancies.4 The result is a uniform table of MRDs, set forth at Prop. Reg. § 1.401(a)(9)-5, Q&A 4(a)(2) of the proposed regulations, which applies whether or not the participant has, in fact, made any beneficiary designation, and whether or not the designee would qualify as a DB.

A different set of rules applies at the participant's death, and it becomes necessary to determine whether a qualified beneficiary has indeed been designated, and which beneficiary has the shortest life expectancy.5 The consequence of the participant not having designated a qualified DB is that the remaining benefit must be paid out: 1) over a period of five years after death, if death occurs before distributions have begun,6 a scenario sometimes referred to as "crash and burn;" or 2) if death occurs after distribution has begun, "at least as rapidly" as if he or she had not died,7 which the new proposed regulations construe to mean over the remaining life expectancy of the participant, based on attained age at the time of death, using the "uniform distribution period" table.8

Under the new proposed regulations, this determination need not be made until December 31st of the year following the year in which the participant died, regardless of whether the participant died before, or after, his or her RBD.9 During that rather generous interval, there is an opportunity for post-mortem planning: Designees who would not qualify as DBs, or whose shorter life expectancies would require a faster payout of the remaining benefit, may disclaim or be "cashed out," so that the MRD will be calculated with reference only to the remaining designees.10

Planning Opportunity

A participant may designate a charity as the beneficiary of a portion (or all) of his or her qualified plan or IRA benefit despite the fact that the charity (not being an individual) would not qualify as a DB, and the designation will have no affect on the participant's MRD, regardless of whether the designation is made before or after the participant's RBD.11 After the participant's death, if the charity is designated only a portion of the benefit (either a specific dollar amount or a fractional share), this fact will not cause a "crash and burn" (in the case in which the participant has died prior to commencing distributions), or an acceleration of the MRDs with respect to the individual beneficiaries (in the case in which the participant has died after commencing distributions), provided the charity is "cashed out" on, or before, December 31st of the year following the participant's death. If the beneficiary designation is to a trust under which the charity is to receive a specific or fractional distribution, the division into separate trust shares must be made by that date.12

Noncontingent Trust Remainders

Under the proposed regulations, the favored method of designating a charity as the remainderman of a trust solely for the life of the surviving spouse will usually be a CRT in whatever form makes the most sense for the surviving spouse. If the account beneficiary designation is to a charitable remainder unitrust (CRUT) under IRC § 2056(b)(8) for the life of the surviving spouse only, the fact that the MRD will be accelerated (the remainder to charity will not be "contingent" because a unitrust, by definition, cannot be exhausted) should not create a problem, in that the CRUT is an exempt entity, and the IRD, though recognized by the trust, will not be taxed until it is distributed to the spouse.

However, the favored form of a CRT for the life of someone other than a surviving spouse is arguably a charitable remainder annuity trust (CRAT). If a NIMCRUT were to be used and the income recipient is someone other than a surviving spouse causing estate tax to be incurred by reason of the inclusion of this income interest in the participant's taxable estate, the IRC § 691(c) deduction for estate taxes paid on IRD will ordinarily be wasted because the distribution of the qualified plan or IRA proceeds to the NIMCRUT will be treated as principal (tier 4), and will not be carried out to the income recipient except where the first three tiers, ordinary taxable income, capital gains, and tax-exempt income, have been exhausted. On the other hand, if the CRAT form of CRT is used, the argument can be made that the remainder to charity is "contingent" for purposes of Prop. Reg. 1.401(a)(9)-4, Q&A 7(b) because it is at least possible that the annuity payout will exhaust the trust.13

If the account beneficiary designation is to a QTIP (qualified terminable interest property) marital trust (i.e., a trust from which the surviving spouse is entitled to receive all current income14), but over which he or she has only a limited power (or no power) to withdraw principal, and only a limited testamentary power (or no power) to appoint the remainder after death, an alternative remainder to charity will not be "contingent" within the meaning of Prop. Reg. 1.401(a)(9)-4, Q&A 7(b), which is to say that the fact that the charity is not a qualified DB will accelerate the MRD, unless: 1) the terms of the QTIP trust require that all distributions from the qualified plan or IRA to the trust be passed directly through to the surviving spouse; and 2) the trustee elects to receive distributions over the life expectancy of the surviving spouse.15 The consequence of such an arrangement, of course, would be that the charity would receive nothing unless the surviving spouse predeceased his or her life expectancy. This situation might arguably be rescued by giving the spouse a limited power to appoint the entire remainder, e.g., to the participant's descendants because this would create a situation in which the alternative remainder to charity might be said to be "contingent" and the individual with the shortest life expectancy within the potential appointive class could be ascertained,16 but this is not clear from the text of the proposed regulations, and there are some private letter rulings that suggest the contrary, albeit in the context of a marital trust over which the surviving spouse had a general power to appoint the remainder at death, and only a limited power (or no power) to withdraw principal during life.

If the account beneficiary designation is to a marital trust over which the surviving spouse has an unlimited power to withdraw principal,17 whether or not coupled with a general power to appoint the remainder at death, the surviving spouse might simply take a lump sum distribution of the plan benefit and roll the proceeds over into his or her own IRA, and in turn might designate the charity without affecting his or her own MRD.

Effective Date

So, when does all of this take effect? The proposed regulations state that the new rules will be effective with respect to distributions for calendar years beginning on, or after, January 1, 2002, but that qualified plan sponsors or IRA owners may elect to apply the new rules with respect to distributions for calendar year 2001.18 In the case of a qualified plan other than an IRA, this would require that the plan sponsor adopt a plan amendment electing into the new rules.19 When the proposed regulations become final, it will be necessary for sponsors, not only of qualified plans but of IRAs as well, to amend their plan documents in order to take advantage of the new rules.20

There was some momentary confusion when the new administration announced a moratorium on the finality of pending proposed regulations. However, the Treasury has continued to issue statements that imply that taxpayers may rely (as described above) on the proposed regulations with respect to distributions for calendar year 2001.


Footnotes

Note: A distribution that is required to be made on, or before, April 1, 2001 because the participant attained age 70½ during calendar year 2000 is a distribution for calendar year 2000.


  1. 66 FR 3928 (01/17/01). Accessible online at http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=2001_register&docid=01-304-filed.back

  2. 62 FR 67780 (12/30/97).back

  3. 26 USC 401(a)(9)(C)(i).back

  4. Explanation of Provisions: The Uniform Distribution Period, 66 FR at 3930.back

  5. Briefly, only an identifiable individual may qualify as a DB. A member of a designated class or a beneficiary of a trust that becomes irrevocable no later than the date of the participant's death may qualify if it is possible to determine, at the participant's death, the identity of the class member or trust beneficiary with the shortest life expectancy. For this purpose, a designee whose potential interest is contingent on the death of another designee is not considered. Prop. Reg. 1.401(a)(9)-4, Q&A 1(a); Prop. Reg. 1.401(a)(9)-5, Q&A 7(c).back

  6. 26 USC 401(a)(9)(B)(ii).back

  7. 26 USC 401(a)(9)(B)(i).back

  8. Prop. Reg. 1.401(a)(9)-5, Q&A 5(c)(3). Literally, "using the age of the employee as of the employee's birthday in the calendar year of the employee's death."back

  9. Prop. Reg. 1.401(a)(9)-4, Q&A 4(a).back

  10. Ibid.back

  11. Prop. Reg. 1.401(a)(9)-4, Q&A 4(a). And see Overview, 66 FRD at 3930.back

  12. Explanation of Provisions: Determination of the Designated Beneficiary, 66 FR at 3931.back

  13. This is not to suggest, of course, that the annuity should be set so high as to violate the 10% minimum remainder value rule set forth in IRC § 664(d)(1)(D) or the 5% probability of exhaustion test enunciated in Rev. Rul. 77-374, 1977-2 C.B. 329.back

  14. To qualify for the marital deduction, the trust must provide that the surviving spouse has the power to require the trustee to withdraw current income from the qualified plan or IRA. See Revenue Rulings 2000-2; 2000-3; IRB 305 (01/18/00).back

  15. Prop. Reg. 1.401(a)(9)-5, Q&A 7(c)(3), Example 3.back

  16. Prop. Reg. 1.401(a)(9)-4, Q&A 5(b)(3).back

  17. An unlimited withdrawal right is required if the participant intends to afford the surviving spouse the opportunity to "roll over" the undistributed benefit to his or her own IRA.back

  18. See 66 F.R. at 3933, 3934.back

  19. Ibid.back

  20. Ibid. A qualified plan that requires distribution on a more restrictive schedule than that permitted under the proposed regulations, e.g., within five years after the participant's death, will not be amended automatically, even with respect to distributions for calendar years 2002 and beyond. Advisors are emphatically urged to read the plan document.back

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