A special planning opportunity for beneficiaries of inherited IRAs will be expiring soon. It comes from an exception built into the final required minimum distribution (RMD) regulations adopted in 2002. Beneficiaries who opted into the five-year rule, whether by accident or on purpose may, if the IRA allows it, switch to a lifetime payout, provided they take the proper steps before Dec. 31, 2003.
Until January 2001, the proposed RMD regulations were highly complex. New, simpler regulations were proposed in 2001 and finalized in 2002.
It appears that the authors of the regulations were concerned that many beneficiaries, especially those who had to begin taking distributions while the rules were in a state of flux, might have defaulted into the five-year rule merely due to confusion surrounding the requirements, rather than as a result of an actual desire to delay distributions under that rule.
Therefore, the final regulations included a special, limited time rule for any beneficiary who is subject to a five-year rule, and it doesnt matter whether he affirmatively elected to follow the five-year rule or ended up there under a default provision.
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Generally, this opportunity affects any nonspouse beneficiary who is taking distributions from an inherited IRA under the five-year rule. The five-year rule requires that the entire account balance be distributed by Dec. 31 of the fifth year after the decedents death. Thus, if your client is the nonspouse beneficiary of an IRA of a decedent who died between Jan. 1, 1998 and Dec. 31, 2001, and he or she has not yet begun receiving distributions, or if the distributions he or she received did not begin until after Dec. 31 of the year after death, he or she will be affected by this rule. Note that different (more flexible) rules apply to spouse beneficiaries.
The beneficiary can switch to the life expectancy method by taking a distribution before Dec. 31, 2003, of the amounts he would have been required to receive had he initially elected a life expectancy payout. Depending on the amounts involved, this could mean a bit of a tax bite for 2003, but the long-term effect is likely to be significant.