Certain clients can delay their required IRA distributions a little longer and pay them out with less onerous tax consequences according to a March 11th IRS Private Letter Ruling. The ruling clarified how required minimum distribution rules apply at retirement to profit-sharing plan participants who made grandfathered "242(b)(2) elections."
The 242(b)(2) election was part of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), which changed the rules applicable to required minimum distributions for plan participants who also owned more than 5% of the business. Before TEFRA, required minimum distributions could be deferred until the later of age 70-1/2 or retirement. However, under TEFRA rules, required minimum distributions must start at age 70-1/2 for plan participants that own more than 5% of the business, regardless of whether they are still working for the firm. Extension of the distribution date beyond age 70-1/2 is only allowed for those who own less than 5% of the firm.
At the time, Congress grandfathered existing plan participants who would fail the new ownership test by allowing them to make a 242(b)(2) election, deferring distribution beyond age 70-1/2 until subsequent future retirement. However, they were required to indicate specific terms for when and how the account would be distributed. The election had to be made by Jan. 1st, 1984.
The current IRS ruling concerns an individual who made a valid 242(b)(2) election in 1983 and is now about to retire at the age of 85. Under his election, he was required to take a lump sum distribution of his retirement plan balance at retirement, whenever that occurred (even if after age 70 1/2). The taxpayer asked the IRS if he could roll over his lump sum distribution to an IRA (avoiding immediate taxation of the full amount), and how distributions must occur thereafter.
The IRS ruled favorably for the retiree overall. It said that the taxpayer could roll over his lump sum distribution to an IRA. However, the 242(b)(2) election itself could not 'rollover', and ceased when the lump sum distribution occurred. Consequently, the taxpayer could not avoid existing required minimum distribution rules any further, and must begin required minimum distributions by April 1st of next year as though he had just reached his required beginning date.
For planners, this means that it's important to ask clients who are over 70 1/2, still working for a firm that they own, and have retirement plan account balances that pre-date TEFRA, whether they made a 242(b)(2) election. If so, they may be able to enjoy many additional years of tax deferral as long as they continue to work, and still be able to ultimately roll over their money into an IRA and begin distributions at a future date.
Michael E. Kitces, MSFS, CFP, CLU, ChFC, RHU, REBC, CASL, is Director of Financial Planning for Pinnacle Advisory Group, a private wealth management firm located in Columbia, Maryland. Michael welcomes your questions and comments at firstname.lastname@example.org.