Changes Brewing For IRA Required Minimum Distributions…
The Senate Committee on Finance recently scheduled a committee markup on September 21, 2016 of an original bill, the “Retirement Enhancement And Savings Act of 2016″ (the “Act”). The actual document was prepared by the Joint Committee on Taxation and includes a number of changes to the required minimum distribution (“RMD”) rules for distributions from employer sponsored retirement plans and individual retirement accounts (“IRA”). While the rules are essentially the same, this blog will address IRAs. Note this is NOT the current law; however, the Act sets forth changes you may be seeing in the future.
Under current law, RMDs must be taken from an IRA once the owner reaches their required beginning date (“RBD”) and a designated beneficiary of an IRA must take RMDs over a period of either 5 years, the life expectancy of the owner of the IRA or the life expectancy of the beneficiary, depending on whether the owner dies before or after the RBD.
The Act changes the distribution period for RMDs payable to a designated beneficiary to five (5) years, regardless of whether the owner dies before or after the RBD. This 5 year rule applies only to IRA date of death balances that exceed $450,000.00.
For example, if an owner of an IRA has $600,000 at the owner’s date of death, the 5 year rule only applies to $150,000. Current law applies to $450,000. Thus, assume Bob names his daughter, Susie, age 40, as a beneficiary of his IRA. Bob dies on February 17, 2017 with an IRA worth $600,000 and Bob is past age 70 1/2. Susie could then take the RMD of $450,000 over her life expectancy and the RMD of the $150,000 would have to be distributed over 5 years after Bob’s death. There are many unanswered questions. What if someone has multiple IRAs? Which IRAs do you take the $450,000 and which the $150,000? Can a beneficiary pick and choose from which IRA the distributions are made? What if there are multiple beneficiaries? Who determines which beneficiaries get the benefit of the life expectancy “stretch” RMD?
The Act provides exceptions to the 5 year distribution rule for an “eligible beneficiary”, who is defined as a surviving spouse, a disabled or chronically ill individual, an individual who is not more that 10 years younger or a child of the owner who has not yet reached age of majority. However, when such child reaches the age of majority, the 5 year rule applies. Further, the 5 year rule applies AFTER the death of the eligible beneficiary.
The proposal is generally effective for RMDs for IRA owners with a date of death AFTER December 31, 2016.
ADVICE: While this Act is NOT current law and enactment of a law is a long process, especially in light of the upcoming Presidential election, this Act gives advisors indications of the thoughts in Washington. Advisors may want to review current beneficiary designations for individuals who have passed away and who have not yet taken distributions. A spouse who is a designated beneficiary may want to disclaim their interest if the contingent beneficiary are individuals with a longer life expectancy. Prior to making a disclaimer, the spouse’s financial situation must be reviewed. Further, the disclaimer must be prepared in accordance with state and tax law to ensure that the spouse is not making a gift of disclaimed IRA proceeds.
WORD OF THE WEEK: Required Minimum Distributions (“RMD”) are distributions that are required to be distributed from an owner’s retirement plan once the owner reaches a certain time in their life, usually when the individual reaches age 70 1/2. Retirement plans, such as 401(k) plans and IRAs are funded during an owner’s life with annual pre-tax contributions (after tax contributions can also be made). Contributions and earnings grow income tax free while the funds remain in the retirement plan.
A planning device for individuals who do not need their IRA benefits is to keep these retirement funds in their plan for as long as possible so no income tax is incurred. Thus, Congress enacted the requirement of RMDs at the owner’s RBD. Except for Roth IRAs and certain other plans, the owner or the beneficiary receiving the RMD must pay income tax on the RMD. Thus, income tax on contributions and earnings in a retirement plan is not avoided but deferred. The RMD is based on IRS life expectancy tables depending on whether the distribution is to the owner during the owner’s lifetime or to a designated beneficiary after the owner’s death.
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