New Rules to Get the Most (or least) From Your IRA

There has been a lot of talk lately about President Bush's proposed tax cuts. But, did you know that a new tax break was recently given to IRA owners? And did you know that it came from a very unlikely source? – The IRS. 

Yes, the IRS has released proposed regulations that can have an immediate effect on those who are taking traditional IRA “required minimum distributions” (called “RMDs”). 

The effect will nearly always produce a smaller income tax bill because you have to take less from your IRA. It also allows the IRA beneficiaries the ability to take less from an IRA as well. 

What is a RMD- required minimum distribution?

This is the amount that you must take out of your traditional IRA each year starting with the year you turn 70 ½.

Must I take my first distribution in the year I turn 70 ½? I've heard I can delay the first one.

You can delay taking your first RMD (and only the first) until April 1 of the year following the year you turn 70 ½. This is called the required beginning date. After the first year's distribution, RMDs must be made by December 31 of each subsequent year.

Thus, it is wise to discuss with your tax advisor the income tax ramifications of taking your first RMD and your second RMD in the same year, which happens if you delay the first RMD until April 1 of the year following the year you turn 70 ½.

You may take distributions in more than one payment, but the total of the payments for the year must at least equal the RMD. If you own more than one account, you may take the RMD from any one or a combination of the accounts. Once again, the total taken must at least equal that year's required minimum distribution.

Is the required beginning date the same for my employer sponsored retirement plan?

No. The rules for distributions from an employer's tax-qualified retirement plan are different. For most participating employees, payments must start by the later of April 1 of the year following (1) the year the participant turns age 70 ½ or (2) the year the employee actually retires. Employees who are more than 5% owners of the company sponsoring the plan must follow the same rules applicable to IRA owners.

Will these new IRS rules about distribution of my RMD involve a bunch of complicated calculations that no one can understand?

The proposed regulations actually simplify the calculations. As in the past, to calculate your RMD, you first add up all of your IRA account balances at the end of the prior year and divide that by a factor from an IRS table.

But in the past, the table you used depended on who, if anyone, was a designated beneficiary of your IRA, the beneficiary's age, and whether you had elected “term certain” or “recalculate” or a hybrid method.

With the new rules, there is one table for nearly everyone to use. This new table assumes that you have a beneficiary who is ten years younger than you, whether you have named a beneficiary or not. The only exception to this is if you have designated your spouse as a beneficiary and your spouse is more than 10 years younger than you. Then you use a different table, which results in an even lower RMD.

You no longer have to make confusing elections.

If I turned 70 ½ in 2000, but did not take my RMD in 2000, can I use the new tables to calculate the amount I must receive by April 1, 2001?

No. The new tables can be used only for 2001 RMD's.

Can I use these new rules in 2001 for RMD's from my 401(k) plan?

Maybe. You may use the new rules for 2001 distributions from a 401(k) plan only if the plan sponsor adopts an amendment to the plan which is contained in the regulations.

Will anyone have a higher required minimum distribution with these new rules?

No. Your RMD will either be the same or less than under the old rules.

What happens if I die and there is still money left in my IRA's?

You still can't take it with you.

The answer depends on whether you have a designated beneficiary or not, and on whether you die before the required beginning date or after. In either instance, by designating a beneficiary or beneficiaries you give more income tax reduction opportunities to your beneficiaries, since they can generally use their life expectancy to calculate their RMD after your death. This is a complicated area and you should get more information.

Are any tax planning opportunities available in these new proposed regulations?

Yes. Right away you have the opportunity to reduce your income taxes in 2001 by electing to use the new table to reduce your RMD.

Your designated beneficiaries have a new opportunity to reduce their income taxes by stretching out the payments after your death. 

Since your designated beneficiaries generally can use their own life expectancy to calculate RMD's, if your spouse doesn't need an IRA, he/she can disclaim the IRA and it will go to the named contingent beneficiaries. If these are your children, you have allowed to stretch the IRA payments out over their life. Naming contingent beneficiaries is important.

This sounds almost to good to be true. Where is the catch?

Your grandfather or grandmother, or maybe even your parents, may have said, “If it sounds to good to be true, it probably is”. Yes, there are benefits under this new proposal, but it isn't all gravy.

The law continues to provide for a 50% penalty excise tax on any portion of a RMD that was not taken in any given year. The prior law, though very complex, had no reporting requirements that facilitated imposition of the excise tax.

The new regulations require minimum distributions to be reported by IRA trustees and custodians, beginning with the 2002 RMD. You can expect further instructions to be issued by the IRS about this reporting requirement. The types of mistakes that went by undetected in the past will undoubtedly not be overlooked for the year 2002 and subsequent years.

There are many planning opportunities available in these proposed regulations. You should find out more so that you can take advantage of the choices available to you.

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