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IRS simplifies retirement plan rules

Updated: May 3, 2013 12:14PM



Originally published: August 7, 2001

In an astounding announcement recently, the IRS changed all the rules for Individual Retirement Account distributions, doing away with mountains of complicated calculations and regulations in one clean sweep.

The new simpler rules apply not only to IRAs, but to 40l(k) and 403(b) retirement plan distributions as well.

No longer will retirees who reach age 70 1/2 be forced to name beneficiaries and choose calculation methods to determine how much they must take out of their retirement plans each year.

Retroactive to Jan. 1, 2001, IRA owners or retirement plan participants can use one simple IRS table to calculate annual required distributions. To determine the amount that must be withdrawn each year, you’ll simply look at a life expectancy figure on the chart. Then, divide that life expectancy into the account balance at the end of the prior year.

(The chart for life expectancies is based on the joint life expectancy for someone your age and someone 10 years younger than you are. Thus, at age 77, the chart will show a 20.1-year life expectancy.

Two big differences

There will be two huge differences as a result of the new rules. First, there will be a lot less aggravation for people reaching age 70 1/2 and trying to figure out the best way to stretch out their retirement plan distributions to let the account keep growing.

Second, many older couples with less than a 10-year age difference between them will now find that they are required to take less money out of their accounts each year, leaving more to grow for future needs or for their heirs.

(Remember, you can always take more than the minimum required annual distribution from your retirement plan. These changes affect people who want to take out the least required amount.)

No longer will IRS participants have to choose between complicated methods such as “term certain,” “recalculation” or “hybrid.”

No longer will you have to name a beneficiary before you start taking distributions in order to stretch out payments over your lifetime and that of your beneficiary.

No matter who you’ve named as your beneficiary--your spouse, child, grandchild--the annual distributions will be calculated off a chart based on your life expectancy and that of a person 10 years younger than you. Only people who have spousal beneficiaries more than 10 years younger can use a longer life expectancy figure.

There’s another bonus. The designated beneficiary of your retirement plan need not be determined until Dec. 31 of the year after you die. That gives your heirs a chance to plan to keep your IRA going as long as possible after your death, with the least possible tax complications, according to Ed Slott, publisher of Ed Slott’s IRA Advisor newsletter (www.irahelp.com).

Slott speculates that the IRS’s new helpful attitude stems from its recognition of the trillions of dollars in these retirement plans, and the IRS is trying to make sure the government gets its share.

After all, these withdrawals are taxed as ordinary income. In fact, there is a penalty of 50 percent if the required amount is not withdrawn every year.

But currently, the IRS doesn’t have a way to check up on whether appropriate withdrawals are made. Slott suggests that this new law will make it easier for every bank, broker or mutual fund company to report on required distributions. Then, knowing your age, the IRS can simply cross-check on compliance.

But the simplified rules don’t absolve you of the need to name a beneficiary and plan for the ultimate distribution of your account. That’s especially important if you want to keep your IRA growing tax-deferred in the future, according to Stephen J. Silverberg, an elder-law expert.

Silverberg gives the example of a 71-year-old retiree who has an IRA worth $500,000 that is invested to earn 8 percent a year. If he dies in 15 years at age 86, taking the required minimum distribution every year, his IRA could still have a lot of growth ahead.

If the retiree had two grandchildren, ages 10 and 7 today, and made them joint beneficiaries of his IRA after his death, today’s 10-year-old would eventually withdraw $6,873,360 over her lifetime. And today’s 7-year-old grandchild, taking minimum distributions over his lifetime after his grandfather dies, would ultimately withdraw $8,262,857!

That tax-deferred, compound growth inside an IRA is a huge benefit. But if you don’t name a beneficiary, your estate gets your IRA assets, and your heirs can only extend withdrawals over your remaining life expectancy.

And one more warning: Many retirement plan and IRA custodians have their own rules, requiring all assets to be “distributed” within five years of the death of the account owner. So make sure your account custodians will set aside the five-year rule, allowing those distributions to continue for generations to come. Or else the heirs must transfer the account to a new trustee.

Bottom line: The IRS gives and it takes. It gives you less aggravation over your withdrawals--and the opportunity for more growth for your retirement plan assets in the future. But it takes a closer look at those withdrawals, to make sure the government gets its share. That’s the Savage Truth.

Terry Savage is a registered investment adviser for stocks and commodities and is on the board of directors of McDonald’s Corp. and Pennzoil-Quaker State Co. Send questions to savage@suntimes.com.



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