Help! My Required Distribution Ate My Retirement Account
Tips on how you can help your client in this situation.
July 19, 2007
by Bruce A. Tannahill, CPA/PFS
What do you do when your client’s minimum required distribution (MRD) for a retirement account exceeds the value of that account?
You may be thinking: “How can that happen? Don’t you compute the MRD by dividing the account balance by the client’s life expectancy?”
Does the client’s retirement account include a deferred annuity? If so, does the annuity offer a feature such as a guaranteed minimum withdrawal benefit or a guaranteed death benefit? These benefits are designed to provide some assurance that owners will receive a specified income and/or their beneficiaries will receive a specified death benefit, regardless of the annuity’s balance. This could be the reason the MRD exceeds the annuity accumulation value (the amount accumulated by the participant under the annuity).
For example, assume Roberta used some of her IRA to purchase an annuity offering a guaranteed minimum withdrawal benefit that allows her to receive annual distributions for life and that they are equal to five percent of a withdrawal base determined under the terms of the annuity contract. Also assume it offers a death benefit equal to the highest annuity accumulation value on a policy anniversary date, reduced by any withdrawals. The date used to determine the death benefit varies from annuity contract to annuity contract.
Each of these features has a value that represents a benefit that is not reflected in the annuity value. Beginning with the 2006 MRDs, the value of those features had to be considered in determining the MRD. These rules apply to annuities held by qualified retirement plans, IRAs and section 403(b) accounts.
Treas. Reg. § 1.401(a)(9)-6, A-12(b), provides that the computation of MRDs from annuity contracts that have not been annuitized may need to reflect the actuarial present value of those additional benefits in addition to the annuity accumulation value. A deferred annuity’s value for MRD purposes can exceed the annuity accumulation value if the annuity:
Two exceptions allow the exclusion of certain additional benefits and those whose value does not exceed 20 percent of the annuity balance.
The actuarial present value of these features must be added to the annuity balance to determine the “entire interest” in the annuity when calculating the MRD. The insurance company that issued the annuity should provide the actuarial present value of those additional benefits and the amount of the MRD for the annuity. This computation is based on the entire interest in the annuity, including both the annuity accumulation value and the actuarial present value of the additional benefits.
If the value of the additional benefits is included in the account balance for determining the MRD, Treas. Reg. 1.401(a)(9)-5, A-1(a)’s provision that the MRD cannot exceed 100 percent of the account balance does not limit the MRD to the annuity accumulation value.
Failure to take the full MRD results in the imposition of a 50 percent excise tax under Internal Revenue Code section 4974(a). The penalty is imposed on the amount that the MRD exceeds the actual amount distributed.
What Can a Client in This Situation Do?
If a client’s retirement plan account includes assets other than annuities, naturally the client can take the MRDs from those assets. Not all retirement accounts, however, are treated as part of the same retirement plan. Reg. § 1.401(a)(9)-8, A-1 provides that MRDs must be calculated separately for each type of qualified retirement plan and distributed from that plan. Similarly, distributions from IRAs and 403(b) accounts cannot be used to satisfy the MRD requirements for other types of accounts.
For IRA accounts, Reg. § 1.408-8, A-9 provides that the MRD is calculated separately for each IRA owned by the same individual but the client can aggregate the total of those MRD amounts and take them from any one IRA. Reg. §1.403(b)-3, A-4 provides the same rules for 403(b) contract. (Note that IRA and 403(b) accounts that are held by an individual as beneficiary cannot be aggregated with similar accounts owned outright by such individuals to meet the MRD. In addition, beneficiary accounts received from different decedents cannot be combined.)
For example, Lewis’ retirement account includes an annuity with an annuity accumulation value of $1,000 and additional benefits valued at $14,000, for a total value of $15,000. (The additional benefits have a high value compared to the annuity accumulation value because Lewis took a partial withdrawal of a substantial portion of the annuity accumulation value, leaving enough to keep the annuity in force and the guaranteed additional benefit was reduced dollar for dollar by the withdrawals, rather than by a comparable percentage.) At Lewis’ age of 85, his life expectancy is 14.8 years. Based on the total value of the annuity, his MRD for the annuity is $1,013.
How can Lewis satisfy the MRD requirement without reducing the annuity account value to zero dollars and losing the additional benefits or being subject to the 50 percent penalty for failure to take his MRD? Some options include:
Naturally, he would need to consider any surrender charges or other restrictions on his ability to make the transfer. In deciding whether the transferred money should be deposited into the annuity, the client and his advisors should evaluate the impact the deposit might have on the value of the annuity’s additional benefits.
If none of these options will work for Lewis, he may be faced with the choice of either taking the entire annuity value, causing him to lose the additional benefits or paying the 50 percent excise tax of $506.50 (50% of the undistributed MRD of $1,013) in the current year.
The guarantees offered by annuities make them very attractive to many clients. The value of those guarantees can affect the annuity’s account balance and the minimum required distributions based on that account balance. Planning that considers this possibility reduces the potential that a client will face a dilemma similar to Lewis’ in the example above.
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Bruce A. Tannahill, CPA/PFS, JD, CLU, ChFC, is vice-president of business and estate planning for Western Reserve Life Assurance Co. of Ohio. Bruce is an attorney, CPA/PFS, CLU, and ChFC, has published numerous articles on income and estate tax planning and has spoken frequently to professional groups. He has been nominated to serve on the Board of Directors of the Society of Financial Service Professionals and serves as the chair of the 2007 LIMRA Advanced Sales Forum, co-chair of the ABA Real Property, Probate & Trust Section eCLE committee, and a representative to the Synergy Summit, a group of seven major financial and legal services organization.
This article represents the views of the author and not necessarily those of Western Reserve Life Assurance Co. of Ohio (WRL). This material is provided for information purposes only and is not tax or legal advice. If legal or other professional assistance is required, the services of a competent professional person should be sought.