President Obama and House Ways and Means Committee Both Propose 5-Year Post-Death Payout Period for Non-spousal Beneficiaries of Qualified Retirement Plans and IRAs

On March 4, President Obama released his federal budget proposals for fiscal year 2015. Although President Obama’s budget proposal does not call for many of the broad tax reforms proposed by the House Ways and Means Committee’s “Tax Reform Act of 2014,” the two documents notably contain similar proposals to simplify the complex required minimum distribution rules that apply when owners of IRAs and participants in employer-sponsored retirement plans die. 

Current Law

Under current law, owners of traditional IRAs and employees in employer-sponsored retirement plans (both defined contribution and defined benefit plans) are subject to required minimum distribution (RMD) rules, which generally require the IRA owner (other than Roth IRAs) or employee (if he has retired) to take minimum distributions beginning at age 70½ or pay a 50-percent excise tax on the amount of such distributions.

Special rules apply when the IRA owner (including a Roth IRA owner) or employee dies before the entire account balance has been withdrawn.

• If the death occurs on or after age 70-1/2, the remaining amount must be distributed to the beneficiaries at least as rapidly as distributed to the decedent as of the date of death (but over the life expectancy of any designated beneficiary, if longer). Absent a designated beneficiary, the distribution period is the remaining life expectancy of the IRA owner or employee at the time of death.
• If an IRA owner or employee dies before age 70-1/2 and any part of the benefit is payable to a designated beneficiary, distributions generally must begin within one year of death and are spread over the life expectancy of the designated beneficiary. If the IRA owner or employee dies before age 70-1/2 and there is no designated beneficiary, the entire remaining account balance generally must be distributed to the estate by the end of the fifth year following the death. 

Proposal

Following the death of an IRA owner or a participant in an employer-sponsored retirement plans; distributions generally would be required within five years (regardless of whether the IRA owner or participant dies before or after RMDs have begun). Distributions to the following beneficiaries could continue to be spread over their life expectancies:

• Spouses
• Disabled beneficiaries
• Chronically ill beneficiaries
• Beneficiaries not more than 10 years younger than the decedent
• Children

However, when the beneficiary dies or a child beneficiary turns 21, the general five-year-distribution rule would apply upon such occurrence.

Rationale 

The tax breaks provided for retirement savings are intended primarily to provide retirement security for individuals and their spouses. Under current law, non-spousal beneficiaries can enjoy tax-favored accumulation of earnings over long periods of time. In addition to addressing the issue of unintended tax breaks to non-spousal beneficiaries, the provision would simplify the current complex RMD rules and reduce the compliance burdens on seniors and beneficiaries of IRAs and other retirement plans.

Effective Date

The provision generally would be effective for distributions with respect to IRA owners or employees who die after 2014.  President Obama’s proposal also specifies that the requirement that any balance remaining after the death of a beneficiary be distributed by the end of the calendar year that includes the fifth anniversary of the beneficiary’s death would also apply to participants or IRA owners who die before January 1, 2014, but only if the beneficiary dies after December 31, 2014.

If you require assistance with your required minimum distributions, please contact Karen McCarthy at (216) 928-5414.

[SIDEBAR]

In addition to the proposed changes to post-death RMDs, President Obama’s budget also contains the following additional proposals related to RMDs: 

1 – Elimination of lifetime RMD requirements for balances of $100,000 or less. The proposal would exempt an individual from the RMD requirements if the aggregate value of the individual’s IRA and tax-favored retirement plan accumulations does not exceed $100,000. The proposal would be effective for taxpayers attaining age 70½ on or after December 31, 2014 and for taxpayers who die on or after December 31, 2014 before attaining age 70½.

2 – Expansion of the RMD requirements to Roth IRAs. Currently, Roth IRA owners are not required to receive RMDs during their lifetimes (although beneficiaries of Roth IRAs are required to receive RMDs following the death of the owner).  President Obama’s budget proposes to apply the RMD requirements to Roth IRA owners such that Roth IRAs will be treated in the same manner as all other tax-favored retirement accounts.  The proposal would be effective for individuals attaining age 70½ after December 31, 2014.