Senators Reed (D-RI) and Harkin (D-IA) have proposed legislation (the Student Loan Affordability Act of 2013 (S. 953)) that would extend the current low (3.4%) interest rate on student loans (which expired on July 1, 2013) for another two years. To pay for that extension, the proposal (among other things) modifies Tax Code minimum distribution rules to restrict the use of ‘stretch’ benefits payouts under IRAs, defined contributions plans (including 401(k) plans) and defined benefit plans.
In this article we discuss the proposed change to the minimum distribution rules.
Under Tax Code minimum distribution rules, a participant is allowed to elect distribution over the lives (or life expectancies) of the participant and a designated beneficiary. If the participant dies after payment has begun under such an election, payments may continue to the designated beneficiary for his or her life (or the life expectancy period).
This rule can allow a participant to pick a very young beneficiary and then ‘stretch out’ benefit payments over a very long joint life/life expectancy, thus deferring taxation of those benefits.
Under the proposal, the general rule would be that if the participant dies after distributions have begun, the entire interest of the participant would have to be distributed within 5 years. If, however, the beneficiary is an ‘eligible designated beneficiary,’ then distributions could generally be made over the life (or life expectancy) of the eligible designated beneficiary.
The participant’s surviving spouse.
A child of the participant.
Disabled (within the meaning of Tax Code section 72(m)(7)).
Chronically ill (generally within the meaning of Tax Code section 7702B©(2)).
Not more than 10 years younger than the participant.
With respect to children, the exception to the general rule ‘expires’ when the child reaches majority, and benefits must be distributed within five years of reaching majority.
There is a special rule for surviving spouses. Payments to the surviving spouse do not have to begin until the date on which the participant would have reached age 70-1/2. And if the surviving spouse dies before all payments are made, rules are applied to the surviving spouse’s beneficiary as if the surviving spouse were the participant.
The new rules would apply, generally, to participants who die after December 31, 2013, so participants in pay status would be affected. There is an exception for pre-existing binding annuity contracts.
Generally, this change, if passed, will require changes in sponsors’ documents and administration. Participants who are using, or considering using, a ‘stretch’ payout as part of, e.g., their estate plan will want to review this proposal to determine how it might affect them.