Friday March 29, 2024

4.6.1 IRA Owner/Spouse Distributions

IRA Owner/Spouse Distributions

Introduction:  IRAs and pension plans are very popular.

SECURE Act Changes:  By a bipartisan vote of 71 to 23 on December 19, 2019, the Senate passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act. The SECURE Act was part of a larger appropriations bill.

Secure Act 2.0  The Secure Act 2.0 was signed into law at the end of 2022 and made many changes to the distribution of retirement benefits.

Ages for Distribution:  There are three principal ages in the IRA distribution rules.

Exceptions to 10% Penalty:  There are exceptions to the 10% penalty on pre-59½ retirement plan distributions.

Distribution Tables:  There are three tables used to determine required minimum distributions (RMDs).

Required Lifetime Distributions:  Distributions are determined by the account balance at the end of the distribution year and the distribution period or life expectancy taken from the applicable table.

Spousal Rollovers:  After an IRA donor passes away with the surviving spouse as sole beneficiary, there are two options.

Introduction


IRAs and pension plans are very popular. Nearly all Americans have one or more of these "qualified plans." According to the Investment Company Institute, there is an estimated $9.4 trillion in IRAs, and total retirement plans now exceed $27 trillion.

There are two principal benefits of qualified plans. For regular IRAs (not Roth IRAs) and employer-sponsored defined benefit and defined contribution plans, contributions are tax free and the balance grows tax free. Of these two benefits, the greatest economic benefit is tax-free growth.

While nearly everyone has an IRA or pension plan and the concept of these plans is straightforward, specific rules govern contributions and distributions.

SECURE Act Changes


By a bipartisan vote of 71 to 23 on December 19, 2019, the Senate passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act. The SECURE Act was part of a larger appropriations bill.

Both House Ways and Means Chairman Richard Neal (D-MA) and Ranking Member Kevin Brady (R-TX) supported the bill. Brady noted, "Our bipartisan legislation makes it easier for main street business to offer retirement plans to their workers by easing administrative burdens, cutting down on unnecessary and often costly paperwork. In this bill, we also offer local businesses the flexibility to tailor retirement plans to best fit the needs of their workers, not to the needs of Washington."

The bill includes many provisions designed to facilitate and enhance savings for retirement. These changes have bipartisan support and are helpful for workers who desire to save for retirement.
  • Traditional IRA Contributions - Individuals over age 70½ with earned income may continue to make contributions each year. Previously, only Roth IRAs could be funded after age 70½. All IRAs may now be funded at any age, provided you have earned income. These traditional IRA contributions may enable seniors to grow retirement accounts during their 70's and 80's.
  • Required Minimum Distribution (RMD) Age - For individuals who turn 70½ after December 31, 2019, the RMD age of 70½ is increased to age 72. Those who reached age 70½ during 2019 must still start their RMDs under the previous law. The increased age RMD rule will benefit many IRA owners who do not need to withdraw distributions. Because the IRA balances will be larger with one or two years of added growth, RMDs at age 72 and future years will be larger. Many loyal donors may choose to increase their IRA rollover gifts after age 72.
  • Part Time Workers - Those individuals who work at least 500 hours per year for three years will be able to participate in qualified retirement plans.
  • Retirement Plan Annuities - The rules are generally expanded to permit more qualified retirement plans to offer annuity payout options. Section 204 of the Act generally limits the liability of employers who offer annuity options in their retirement plans. This employer protection is likely to increase the number of annuity options in many larger retirement plans.
  • Retirement Benefit Disclosure - Retirement plan administrators are now required to offer an expanded disclosure of future retirement benefits to participants. These disclosures are intended to help employees better understand the benefits of maximizing their contributions to the retirement plans.
  • Stretch Distribution Reduced - Inherited IRAs for nonspouse beneficiaries will no longer be distributed over life expectancy, but IRA and other qualified plans of decedents must be paid out over a maximum term of ten years. There are exceptions for recipients with disabilities, minors and individuals who are within ten years of the age of the IRA owner.
  • IRA Rollover Limit Potentially Reduced - If an individual makes contributions to a traditional IRA after age 70½, the $100,000 per year qualified charitable distribution (QCD) limit is reduced by the amount of IRA contributions after that age. The IRA contribution amount is cumulative and specific calculations will eventually be published in IRS Regulations. QCD gifts in excess of post age 70½ traditional IRA cumulative contributions will be included in income and deductible if the individual itemizes deductions. It is probable that most donors either will not have earned income after age 70½, will have total income over the IRA phaseout limits (and may not fund an IRA) or may choose to make Roth IRA contributions.

Secure Act 2.0


The Secure Act 2.0 was signed into law at the end of 2022 and made many changes to the distribution of retirement benefits.
  1. Required Minimum Distribution Age -- Starting in 2023, the age for required minimum distributions (RMDs) will increase from 72 to 73. The RMD age will increase in 2033 to age 75 for individuals who attain age 74 that year. Individuals who are currently taking RMDs will continue to take a distribution each year based on their age. Individuals who are employees and not owners of 5% or more of their company may defer RMDs until retirement, even if that is after age 73 or 75.
  2. Catch-Up Contributions -- Individuals who are age 50 and older are permitted to make an additional catch-up contribution. Starting in 2025 individuals who are 60, 61, 62 or 63 will be permitted to make a larger catch-up contribution to Sec. 401(k), 403(b) or 457 plans. The new amount will be the greater of $10,000 or 150% of the catch-up limit for that year.
  3. Matching Contributions for Student Loan Payments -- Many younger workers have substantial student loans and may not be able to make both their student loan payments and fund a retirement plan. Employers will be permitted to match the student loan payments with a contribution to a Section 401(k) or 403(b) retirement plan.
  4. Roth 401(k) Plans Exempt From RMDs -- The Roth IRA is currently exempted from distributions even if the owner has reached the normal RMD age. Starting in 2024, Roth 401(k) plans also will be exempted from RMDs. With no required distributions, Roth IRA and 401(k) plans will be permitted to increase in value during the life of the owner.
  5. Required Minimum Distribution Penalty Reduced -- The existing penalty for failing to take a required minimum distribution is 50%. Starting in 2023, this penalty will be reduced to 25%. If the plan participant corrects the failure in a timely manner, the excise tax on the penalty is further reduced to 10%.
  6. Section 529 Plans Rolled Over to Roth IRAs -- A Section 529 plan is frequently used for college savings. If the 529 plan has existed for 15 years and is no longer required because the beneficiary has completed his or her education, then up to $35,000 of that plan may be rolled over into a Roth IRA for the benefit of that individual.
  7. Qualified Charitable Distributions Enhanced -- The IRA charitable rollover or qualified charitable distribution (QCD) limit of $100,000 for 2023 will be indexed for inflation starting in 2024. In 2024, the QCD limit is $105,000. Individuals age 70½ or older are permitted to make distributions from their IRA directly to charity and avoid recognition of income. The act expands the QCD by allowing a one-time transfer of up to $50,000 to a charitable remainder annuity trust, standard charitable remainder unitrust or immediate charitable gift annuity. In 2024, the QCD to a CRUT or CGA limit is $53.000
  8. Roth Catch-Up Contributions -- Individuals age 50 and above are permitted to make a catch-up contribution to a retirement plan. Starting in 2024, individuals who have incomes over $145,000 will be required to transfer their catch-up contribution to a Roth 401(k) or IRA. This will require them to pay tax on the catch-up contribution, but the future distributions from the Roth account will be tax-free.
  9. Charity as Remainder Beneficiary -- Individuals with a disability or chronic illness may take IRA distributions over their life expectancy, rather than ten years. If a qualified charity is the remainderman in a trust for the beneficiary who is disabled or chronically ill, the life expectancy stretch is still permitted.

Ages for Distribution


There are three principal ages in the IRA distribution rules. Since the IRA is intended to be used for retirement, there is a 10% penalty for most withdrawals prior to age 59½. Sec. 72(t)(1). The pre-59½ distribution would subject the IRA owner to both ordinary income tax on the distribution and an additional 10% penalty. The same 10% withdrawal penalty applies to 401(k) plans.

Exceptions to 10% Penalty


However, there are many exceptions to the early withdrawal penalty. Funds may be withdrawn from qualified retirement plans in specific instances due to disability, a qualified birth or adoption and medical expenses. If an employee retires after age 55, withdrawals from the former employer's plan are penalty-free even if the employee is not 59½. Distributions can also be taken from any inherited retirement plan regardless of the age of the decedent or beneficiary. In addition, distributions that are part of a payment under a phased retirement annuity or a composite retirement annuity under Sections 8366 or 8412 are not penalized. IRA owners also get exceptions for first-time home purchases, tuition payments, and health insurance premiums. Specific restrictions and limits apply to all these withdrawals.

The most common exception to the 10% rule is the Series of Substantially Equal Periodic Payments (SOSEPP). There are three general methods for calculating the distribution. See. Rev. Rul. 2002-62. The distributions must be taken until age 59½ or for a minimum of five years. Sec. 72(t)(4)(A).

Between age 59½ and the individual's age at which RMDs are required to begin is the optional withdrawal period. Any amount may be withdrawn and there is no 10% penalty tax, but the withdrawal is subject to ordinary income tax.

The "Required Beginning Date" (RBD) is April 1 of the year following the year in which an IRA owner reaches the applicable age. The distribution for the year in which the IRA owner reaches the applicable age may be deferred until April 1 of the following year. However, this deferral would result in two distributions being taken that year. Thus, many IRA owners choose to take the first required distribution in the first available year. Sec. 401(a)(9)(A).

Prior to 2023, if the required distribution was not taken, there was a penalty of 50% of the amount of the required distribution that was not paid out to the IRA owner. Sec. 4974. Starting in 2023, the penalty is reduced to 25%. If the plan participant corrects the failure in a timely manner, the excise tax on the penalty is reduced further to 10%. If the required distribution is not taken, there is a penalty of 50% of the amount of the required distribution that was not paid out to the IRA owner. .

Distribution Tables


The required minimum distributions (RMDs) are calculated using the tables located in Reg. 1.401(a)(9)-9, A-2. The table below is used when the surviving spouse is less than 10 years younger than the employee or when the surviving spouse is not the sole designated beneficiary. If the surviving spouse is more than 10 years younger than the IRA owner, the "Joint and Last Survivor Table" in Reg. 1.401(a)(9)-9, A-3 is used.

Lastly, if an IRA owner passes away and the distributions are to be made to a spouse or child from the IRA, then the "Single Life Table" in Reg. 1.401(a)(9)-9, A-1 is used. Under Reg. 1.401(a)(9)-9, A-2, the age, distribution and approximate minimum percentage distributions are as follows:

Uniform Lifetime Table with Minimum Distribution Percentage(s)


AgeDistribution PeriodMinimum Distribution %
7227.43.7%
7326.53.8%
7425.83.9%
7524.64.1%
7623.74.2%
7722.94.4%
7822.04.6%
7921.14.8%
8020.25.0%
8119.45.2%
8218.55.4%
8317.75.7%
8416.86.0%
8516.06.3%
8615.26.6%
8714.47.0%
8813.77.4%
8912.97.8%
9012.28.3%
9111.58.8%
9210.89.3%
9310.19.9%
949.510.5%
958.911.2%
968.412.1%
977.812.8%
987.313.7%
996.814.7%
1006.415.6%
1016.017.0%
1025.617.9%
1035.219.2%
1044.920.4%
1054.621.7%
1064.323.3%
1074.124.4%
1083.925.7%
1093.727.0%

Required Lifetime Distributions


Distributions are determined by the account balance at the end of the distribution year and the distribution period or life expectancy taken from the applicable table. For most IRA owners, the "Uniform Lifetime Table" will be used.

Example 4.6.1A Single Person RMD

John Donor is 75 in the year 2006. His account balance on December 31, 2005 is $500,000. Under the Uniform Table, the Age 75 Applicable Distribution Period is 22.9 years. Dividing $500,000 by 22.9 produces a withdrawal of $21,834. This amount must be withdrawn prior to the end of 2006.

If there is a spouse more than 10 years younger, a similar calculation is completed, but the Joint Life Expectancy Table is used.

Example 4.6.1B Young Spouse

John Donor is age 75 and marries Susan, age 55, on January 2. Since marital status is determined on January 1, John and Susan do not use the Joint Life Expectancy Table until he is 76 and she is 56. Reg. 1.401(a)(9)-5, A-4(b). At the end of the prior year, assume that the IRA balance is $550,000. This balance of $550,000 is divided by the 29.5 years Applicable Distribution Period and the withdrawal is $18,644. This is now permitted because the spouse is the "sole beneficiary" for the entire year when the IRA owner is 76.

Note that under the surviving spouse "sole beneficiary" rules, marital status is determined on January 1, and the distribution is based on the two lives even if the spouse dies or there is a divorce, so long as the IRA owner does not change the beneficiary until the next year.

Spousal Rollovers


After IRA donor passes away with the surviving spouse as sole beneficiary, there are two options. The surviving spouse may receive distributions under the IRA owner's plan. In this case, distributions will commence the year following the year of death of the IRA owner. If the IRA owner has not yet reached age 70½ and started distributions, the distributions will commence on the date after which the IRA owner would have reached age 70½. Sec. 401(a)(9)(B)(iv).

If the spouse receives the IRA distributions from the IRA owner's plan, then he or she may use the Joint and Last Survivor Table to calculate his or her RMD. Alternatively, the surviving spouse may use the Single Life Table to calculate his or her RMD. However, if the Single Life Table is used, the RMD is based upon the spouse's life expectancy in the year after the owner's death. In addition, the rollover spouse's life expectancy under the Single Life Table must be recalculated each year, which increases the surviving spouse's life expectancy and lowers the RMD.

Using the Single Life Table will result in larger RMDs than the Uniform Lifetime Table. As a result, most surviving spouses choose the second option in which the surviving spouse rolls over the deceased spouse's IRA. Under this more popular option, the rollover may be completed at any time, even after the spouse has taken distribution from the IRA. If the spouse rolls over the IRA, then he or she will take distributions under their own RMD schedule. The rollover usually results in lower RMDs and allows the spouse to select the designated beneficiary. Reg. 1.408-8, (A)-5(a).

Example 4.6.1C Spousal Options

Joe and Riley were married for five years. Joe passes away at age 75, the year that Riley is age 74. At age 75, Riley either takes the distribution from Joe's IRA based on a one-life expectancy at age 75 or rolls the IRA over. Joe's IRA is $500,000 and Riley's one-life expectancy is 13.4 years. If Riley takes the distribution from Joe's IRA, the amount is $500,000 divided by 13.4, or $37,313. Alternatively Riley decides to roll over the IRA. The distribution at age 75 based on the $500,000 balance and the Uniform Table expectancy of 22.9 is now $21,834. By rolling over, Riley has reduced the minimum required distribution by about 40%. Therefore, Riley chooses to roll over the IRA account.

Private Letter Rulings

PLR 199948039 IRA Rollover, Division and Recalculation Approved:   Husband A and wife B each designated the other as beneficiary prior to their required beginning dates at age 70½. After husband A had reached age 70½ and started to take distributions, he passed away in 1997. In 1998, the surviving spouse rolled over his IRA and, after then dividing it into four IRAs, sought approval from the Service on several issues.

PLR 200008044 IRA Trust Divided Into Four Sub-Trusts:   Prior to his required beginning date (RBD) in 1992, grantor created an irrevocable trust and designated this "IRA trust" as the beneficiary of an IRA. He then received the required minimum distributions with the eldest of his four children as the designated recipient. Under the minimum distribution rules, the eldest was deemed to be 10 years younger than the grantor.

PLR 200434022 Filing Wrong IRA Rollover Form Triggers Taxable Income:   During his time at Big Corp, Edward Employee participated in Big Corp's retirement plan. The retirement plan was a combination Employee Stock Option Plan (ESOP) and Sec. 401(k) plan. A portion of Edward's ESOP was invested in Big Corp stock. The rest of Edward's ESOP and his 401(k) plan consisted of a diversified portfolio of mutual funds.

PLR 200440026 Employee Granted Additional Time to Roll Over Company Plan into IRA:   Edgar Employee worked for National Corp and, during his employment, Edgar participated in National Corp's retirement plan. After many years, Edgar terminated his employment with National Corp.

PLR 200453016 Spousal Estate IRA Rollover Permitted:   Father had three IRA accounts and selected his estate as beneficiary of the accounts. Mother is the surviving spouse, the personal representative of the estate and the sole beneficiary of the residuary of the estate. The three IRAs are all part of the residuary of the estate. Mother proposes that she should be permitted to distribute the three IRAs to the estate and then roll them over within 60 days into her own IRA. Sec. 408(d)(3)(A)(i).

PLR 201807010 IRA Distribution Rollover Requirement Waived:   Taxpayer received a distribution from IRA Annuity. Taxpayer's financial advisor invested IRA Annuity funds in bonds, mutual funds and certificates of deposit.


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