Testimony of
Investment Company Institute

Submitted at the Internal Revenue Service Hearing
On Proposed Regulations on
Required Minimum Distributions

June 1, 2001

Table of Contents

I. Introduction
Good afternoon. My name is Louis Denkovic, ERISA/Benefits Counsel for Citigroup Inc. I am testifying on behalf of the Investment Company Institute,¹ the national association of mutual funds. These Proposed Regulations are of great interest to Institute members, many of whom offer IRAs, qualified retirement plans and 403(b) arrangements to their shareholders. As of year-end 2000, approximately 46% of the $2.7 trillion IRA market was invested in mutual funds and 44% of the $2.6 trillion defined contribution plan market was invested in mutual funds.²

I would like to thank the Treasury Department and the Internal Revenue Service for giving me this opportunity to testify today. The Proposed Regulations provide a substantially simpler method for calculating RMDs, which would eliminate many of the variables taxpayers must consider under the current proposed regulations. Taxpayers will be able to calculate their own annual RMD more easily, likely resulting in a substantial increase in taxpayer compliance. Furthermore, most taxpayers will benefit from a slower rate of distribution from their employer-sponsored retirement plans, IRAs and 403(b) arrangements. For all of these reasons, we applaud the Service's efforts in developing the proposal.

Nevertheless, we believe the Proposed Regulations could be improved in certain respects. The Institute has filed a comment letter with the Service detailing our suggested changes, which we ask the Service to consider seriously before finalizing the Proposed Regulations. For purposes of today's hearing, however, we will limit our testimony to our concerns and suggestions regarding the new proposed reporting requirement that would be imposed on IRA trustees. In light of these concerns, we offer two alternative methods to assist taxpayers in complying with the rules and the Service in monitoring for compliance.

II. IRA Reporting Requirements
According to the preamble to the Proposed Regulations, the Service intends to require IRA trustees to report annually the RMD for an IRA to the IRA owner or beneficiary and to the Service. The purpose of this new reporting requirement, is to improve compliance and further reduce the burden imposed on IRA owners and beneficiaries. While we support these objectives, we are deeply concerned that the Service's proposed reporting requirement will result in both the Service and a substantial number of taxpayers receiving inaccurate tax information. This will lead to more, not less, taxpayer confusion regarding RMD obligations and will be of little value to the Service's enforcement efforts. It could also severely undermine taxpayer confidence in the tax reporting system and the trust that mutual fund shareholders place in the financial institutions managing their retirement assets. Taking into account the types of data that trustees currently maintain about IRA owners, their spousal beneficiaries and other beneficiaries, there are significant limitations to what trustees would be able to report accurately.

The segment of our population subject to the RMD rules is a significant one. Current census data estimate that almost 9% of the population-about 25 million Americans-is 70 years old or older. Approximately 16 million households have a head of household that is 70 years old or older. Of these households, approximately 5.2 million own an IRA subject to the RMD rules.³ Many of these households own more than one IRA. Indeed, ICI data suggests the average IRA-owning household has two IRAs.⁴ Thus, in essence, the Service is considering imposing a new rule that could require IRA trustees to perform over 10 million RMD calculations and issue 10 million reports to an estimated 5 million households. As I will now explain, many of these reports will likely provide inaccurate information.

The inability of trustees to ensure the accuracy of the RMD amounts they would be required to provide IRA owners and the Service arises from the very nature of the RMD rules. Although the Proposed Regulations would significantly simplify RMD calculations, different RMD calculation rules would continue to apply under various circumstances. IRA trustees, however, frequently cannot identify when these circumstances occur.

The most obvious example concerns spousal beneficiaries. If an IRA owner's sole beneficiary is a spouse more than 10 years younger, the IRA owner can choose a joint life expectancy calculation rather than using the Uniform Table. This will result in a longer payout of the IRA. This rule is based on an important public policy goal- to ensure that spouses of IRA owners have adequate retirement income for their lifetime once an IRA owner dies.

For an IRA trustee to identify these cases and accurately calculate the RMD, it would need to know facts beyond the IRA owner's age, including whether the IRA owner is married, whether he or she has named his or her spouse as the beneficiary of the IRA and the age of the spouse. Most IRA trustees do not currently maintain this information.

The number of IRA owners who would be eligible for the spousal exception is quite significant. Over 14% of Americans aged 70 and older are married to a spouse more than 10 years younger.⁵ This represents approximately 2 million individuals. Applying this data to IRA-owning households, we can estimate that IRA trustees would likely issue close to 1 million RMD reports to households subject to the spousal exception rule. For these individuals, IRA trustees would likely report an incorrect RMD amount to the Service and to the IRA shareholder.

Another situation in which IRA trustees likely will report inaccurate RMD amounts under the IRS's proposal occurs when there is a rollover that crosses calendar years. IRA owners and their beneficiaries often transfer their IRA account balances among financial institutions. When such transfers occur at year-end, the IRA trustees will be unable to calculate an accurate RMD amount, because the December 31 balance will not reflect the rollover amount. For example, the Proposed Regulations state that if an amount is distributed from one IRA in year 1 and rolled over to another IRA in year 2, the rollover amount is treated as having been received by the second IRA in year 1. To comply with this rule, the IRA trustee receiving the rollover would have to adjust the prior year-end account balance to account for rollovers that are initiated in one calendar year and completed in the next. IRA trustees currently track and report financial transactions that occur within their complex only. Because IRA trustees receiving rollover amounts cannot calculate the RMD based on the previous year's ending balance at another institution, including the rollover amount, they will produce inaccurate RMD calculations.

An additional issue related to adjusting year-end account values for calculating and reporting RMD amounts is the impact such adjustments likely will have on correct Form 5498 reporting of year-end account values. Most IRA trustees will need to systematically adjust the year-end account values in order to calculate and report RMDs under the Proposed Regulations. Invariably, year-end account values will not be "unadjusted" in trustees' systems to then provide proper Form 5498 reporting of year-end account values. This will result in improper reporting of this information to the Service, further exacerbating the problems created by incorrect reporting.

Other problems that IRA trustees will face in reporting accurate RMD amounts include:

Lack of date of birth information for IRA owners and beneficiaries. Although today's IRA application form typically asks for the IRA owner's date of birth, this information is not required to open an account and many IRA owners refuse to provide it. The problem is more significant in older accounts, because in years past the information was less frequently included as part of the account application. Many IRA trustees have attempted to obtain date of birth information with limited success. ICI members indicate that they lack IRA owner date of birth information for anywhere from 2% to 15% of their IRAs. An even greater problem exists with respect to dates of birth for IRA beneficiaries. Trustees typically do not retain this information. Without date of birth information, trustees are unable to calculate and report RMDs for their IRA shareholders.

Death of Accountholder or Beneficiary. IRA trustees frequently are not informed on a timely basis about an IRA owner's death. Trustees typically learn of the IRA owner's death at the time a beneficiary requests a distribution. This often occurs in a calendar year other than the year of death. According to the most recent data, the death rate for the population aged 65 and older is 6 times the death rate of the general population.⁶ A 5-percent "error" rate for providing RMDs for IRA shareholders who have died unbeknownst to the IRA trustee would result in about a half million incorrect RMD reports being sent to IRA owners and the Service every year.

Multiple IRAs with Multiple Trustees. Many taxpayers have more than one IRA account, each of which is frequently custodied by a different financial institution. These taxpayers may calculate the RMD for each IRA, aggregate the RMD amounts and take the RMD from any one or more of their IRAs. If each IRA trustee reports the RMD amount for each IRA, taxpayers are likely to infer that a specific amount must be distributed from each IRA, contrary to the rules. Such distributions may not be in the taxpayer's best interest, as taxpayers may choose to take distributions depending upon, for instance, the account's performance, long-range investment planning or liquidity.

Multiple IRAs and First Year's Calculations. Due to the aggregation rules, an IRA trustee will not necessarily know if an IRA owner deferred his or her RMD payment in the first year -- until April 1 of the following calendar year after he or she turns 70 ½. If an IRA owner does defer his or her first RMD, the RMD for the second year must be based on the previous year's adjusted year-end balance, taking into account the delayed RMD. For reporting purposes, IRA trustees would be unable to adjust the year-end balance in time to report the second year RMD to the IRA owner. This would result in IRA trustees reporting incorrect RMD amounts for at least 2 consecutive years in a row.

Life Events Affecting the Calculation. IRA owners aged 70 ½ can undergo life changes that will affect their RMD calculation. As noted above, the death of the IRA owner or death of the IRA owner's spouse will affect the RMD required. Similarly, divorce, marriage or change in a beneficiary designation can each affect the RMD calculation. IRA trustees are not always aware of these changes in circumstances and, even when they are informed of such changes, it often will not be on a timely basis. As a result, IRA trustees will likely report inaccurate RMD amounts in these circumstances.

In summary, although it is difficult to estimate the number of RMD reports that would be inaccurately reported by IRA trustees under the Service's proposal, it is safe to say that the number will be substantial. If we merely account for deaths and the spousal exception, we estimate that approximately 1 ½ to 2 million incorrect RMD reports could be sent to IRA owners and the Service annually. Of course, this number will increase dramatically as the Baby Boomers reach retirement and become subject to the RMD rules.

III. Reporting Alternatives
For all of these reasons, we believe that the proposal to require trustees to report RMD calculations to IRA owners and the IRS is ill advised. Instead, we would recommend that the Service consider two alternative approaches. Under the first alternative, trustees would be required to provide IRA owners and beneficiaries with information designed to notify them of the RMD rules and how to calculate the amount. In addition, trustees would be required to provide the Service with available date of birth information for their IRA owners. Under the second alternative, taxpayers would include their dates of birth on Form 1040 and refer to worksheets to calculate their RMD amounts. Both approaches would (1) make taxpayers aged 70½ and older and taxpayers who have inherited IRAs aware of the RMD rules; and (2) facilitate correct calculation of RMD amounts. Thus, they would achieve the Service's goals of improving compliance and reducing burdens on IRA owners and beneficiaries. At the same time, they would avoid the potential confusion and other harms of the Service's reporting proposal.

Approach 1: Notification of RMD Status by IRA Trustee
Under the first alternative, which we call the "notification approach," the Service could require IRA trustees to (1) help the Service identify IRAs that may be subject to the RMD rules; (2) help the Service identify when the death of an IRA owner occurs, where such information is available; (3) notify IRA owners aged 70 ½ and older annually about the RMD rules; and (4) provide a one-time notice to IRA beneficiaries regarding the RMD rules applicable upon death of an IRA owner when such beneficiaries identify themselves to the trustee or establish an inherited IRA with the trustee.

The Service could require trustees to provide it with available date of birth information for all of their IRA owners. Such date of birth information could be incorporated into the current annual Form 5498 filings that IRA trustees make with the Service. Although trustees do not have date of birth information for all IRA owners, the information that trustees currently maintain regarding IRA owners' dates of birth would certainly be useful to the Service in monitoring for RMD compliance.4⁷

In the alternative, the Service could add a checkbox to Form 5498 that indicates "this account may be subject to the RMD rules." A trustee could check this box when it has date of birth information that indicates the IRA owner is 70 ½ or older.

In addition, trustees could be required to provide notification to the Service when they receive information that an IRA owner has died. When a beneficiary notifies an IRA trustee that an IRA owner has died, the trustee typically changes the registration on the IRA account. This change in registration to the IRA, which would be included in the Form 5498 filing, would put the Service on notice that an IRA owner has died. The Service may want to consider adding a check-box on Form 5498 indicating that the IRA owner has died.

IRA trustees also could be required to provide IRA owners age 70 ½ and older, for whom they have date of birth information on file, an annual notice explaining the RMD rules and referencing appropriate IRS publications, worksheets and other guidance. The notice could include (1) a statement that the IRA trustee's records indicate that the IRA owner is 70 ½ or older; (2) a general statement regarding the applicability of the RMD rules to the IRA owner; (3) a statement that it is the IRA owner's responsibility to calculate the RMD amount each year; (4) information (either by reference or included in the notice) regarding the RMD calculation methods; and (5) an explanation of the aggregation rules.

Information regarding the RMD calculation methods could include reference to an IRS publication or RMD "calculator" that is either web-based or a paper worksheet. RMD calculators would lead a taxpayer through the simplified RMD calculation rules and help the taxpayer apply the rules to his or her own unique circumstances. By comparing the amount of the RMD to any IRA distributions made that year, the calculator would help the taxpayer determine whether additional distributions from his or her IRA were necessary. It also would clarify that the RMDs may indeed be made from any one or multiple IRA accounts, thus reducing taxpayer confusion. The ICI included an example of an RMD worksheet in its comment letter.

Finally, the Service could require that, upon determination of the beneficiary(ies) after the death of an IRA owner, the IRA trustee provide each known beneficiary with a notice similar to the one provided to the IRA owner over age 70 ½ regarding the applicability of the RMD rules. This notice to the beneficiary should be required only when the IRA trustee is notified of the death of the IRA owner (typically at the time of request for payment).

We believe this "notification approach" would best ensure taxpayer awareness of the RMD rules and correct calculation of RMD amounts. It also would avoid circumstances where IRA trustees calculate and report inaccurate RMD amounts to the IRA owner and the Service, and it takes into account the fact that the IRA owner is in the best position to calculate his or her annual RMD because only he or she has all of the information necessary to do the calculation.

Approach 2: The Form 1040 Alternative
Another alternative to a trustee calculating and reporting possibly incorrect RMDs for IRA owners is having the taxpayer include his or her date of birth on the Form 1040 and calculate his or her RMD from IRAs using a worksheet that is incorporated into the Form 1040 instructions. If Form 1040 contained date of birth information for an IRA owner, the Service could ascertain which taxpayers are subject to the RMD rules. Because Form 1040s are signed under penalties of perjury, the information would be more accurate than that obtained from IRA trustees. Using the Form 1040, the Service could access the information necessary to determine whether the IRA owner was subject to the RMD rules, the amount of the RMD for that IRA owner and whether he or she had taken a distribution from his or her IRA to satisfy the RMD rules for that year.

For example, from date of birth information included on Form 1040, the Service could determine whether an IRA owner was over age 70 ½. Form 1099-R information included in the return would provide information regarding the amounts distributed from IRAs for that year. Form 5498 information submitted to the Service would provide the fair market value of all of the IRA owner's accounts for the previous year. Given this information, the Service could readily review the accuracy of the information reported on an IRA owner's Form 1040 to ensure compliance with the RMD rules. If the Service adopts this approach, it may want to consider extending the December 31 deadline for RMDs to April 15 for all taxpayers. This would ensure that a taxpayer who calculates his or her RMD while preparing his or her tax return would have time to take an RMD to satisfy the RMD rules.

IV. Impact of Reporting
In sum, we wish to express our support of the Service's goals of improving taxpayer awareness of the RMD rules and increasing RMD compliance. However, a rule that results in furnishing taxpayers with unreliable or inaccurate information is a serious problem. We are concerned with additional problems that are likely to result as well. One is the impact that such reporting would have on the relationships between IRA trustees and their customers. Customers have come to expect reliable, accurate and timely service from mutual fund firms that serve as IRA trustees. Under the current reporting system, IRA trustees have strong confidence in any dollar amounts reported to IRA owners and the Service. For example, IRA trustees can report accurately contributions, distributions and year-end account balances of IRAs. A reporting system that could result in the reporting of unreliable and inaccurate information to IRA owners would undermine consumer confidence. Similarly, public confidence in the Service's tax reporting and compliance systems also would be threatened if taxpayers were to receive data that turned out to be unreliable or inaccurate. This would be an unfortunate legacy of the Proposed Regulations and contrary to the objective of improving compliance.

On behalf of the Investment Company Institute, I appreciate this opportunity to share these comments with you and welcome any questions you may have concerning my testimony.

¹The Investment Company Institute is the national association of the American investment company industry. Its membership includes 8,500 open-end investment companies ("mutual funds"), 492 closed-end investment companies and 8 sponsors of unit investment trusts. Its mutual fund members have assets of about $6.609 trillion, accounting for approximately 95% of total industry assets, and over 83.5 million individual shareholders.

²2001 Mutual Fund Fact Book (Investment Company Institute).

³MacroMonitor 2000, SRI International, 2000.

⁴"IRA Ownership in 2000," Fundamentals, Vol. 9, No. 5, October 2000, Investment Company Institute.

⁵Warshawsky, Mark, "Further Reform of Minimum Distribution Requirements for Retirement Plans," Tax Notes Today (April 9, 2001).

⁶Murphy, Sherry L., Deaths: Final Data for 1998. National Vital Statistics Reports; Vol. 48, No. 11. Hyattsville, Maryland: National Center for Health Statistics. 2000.

⁷We note, however, that the date of birth information maintained by trustees may not be completely accurate. Because trustees must rely on date of birth information provided by the taxpayer, it is sometimes incorrect.