Article:
New Options For An Old Vehicle—IRAs
by Robert K. Roskoph/Paul H. Roskoph
July 1, 2006
Individual Retirement Accounts (IRAs) have been around for more than 30 years to provide an additional vehicle for saving for retirement. While the saving portion wasn't a problem, determining how much an individual was required to withdraw to satisfy the "minimum distribution rules" became a mathematical nightmare. In some cases, making a wrong decision forced the heirs of an individual saving in an IRA to pay tax on the full value of the IRA all in one year. Beginning in 2001, all of this changed and the calculations and minimum distribution rules are now substantially simpler.
Some rules remain the same. The participant must begin withdrawing funds from the IRA measured by the year in which the participant turns 70_. You may take that first distribution during that year or, you may wait until April 1 of the following year to disburse the money. However, if you wait until the following year you will be forced to take two distributions in that subsequent year. It is important, therefore, to speak with your CPA or other tax professional to analyze your tax situation to determine whether it is best to take the withdrawals in two different tax years or combine the mandatory tax withdrawals into a single year.
The real impact from the new rules comes when calculating the amount of the required withdrawal. The only factors relevant now are the individual's age and the total balance of the IRA at the end of the prior year. Taking the individual's age, and using a chart, a "devisor" is used to determine the required minimum distribution based on the value of the account. The only remaining exception is if the participant is married to a person who is more than 10 years younger than the participant and that individual is the beneficiary on the account. In such a case the required minimum distribution actually decreases, because it is based on the actual joint life expectancy of the participant and the younger spouse.
IRA beneficiaries can rely on the final 2002 rule. At the time the participant dies, the beneficiaries will be able to take withdrawals over their own life expectancies. There is one simple rule: The full amount of any IRA distribution to a beneficiary will be subject to federal income tax. The complicated question is "when must a beneficiary withdraw the money from the IRA?"
As a general rule, following the death of the IRA participant the beneficiary can withdraw the funds over his or her remaining life expectancy. The beneficiary's remaining life expectancy is determined using the age of the beneficiary in the year following the year of the IRA participant's death, then reduced by 1 for each subsequent year. The IRA beneficiary must make the first distribution no later than December 31 of the year following the year of the participant's death. This assumes, however, that there is a single beneficiary, who is an individual. The "simplified" rules become complicated when there are either (1) multiple beneficiaries or (2) a non-individual beneficiary, such as the participant's estate. If the beneficiary participant failed to designate a beneficiary, the distribution answer depends upon whether the participant died before or after his or her "required beginning date" (the RBD) or April 1 of the year following the year in which the IRA owner attains age 70 _. If the participant dies on or after the RBD and has no designated beneficiary, then the distribution period is the IRA participant's life expectancy calculated in the year of the participant's death, reduced by 1 for each subsequent year. If the IRA participant dies before RBD and there is no designated beneficiary, then the IRA must be distributed within 5 years after the death of the participant. Regardless, whether there is a "designated beneficiary" must be determined by September 30th of the year after the participant's death.
There is one major exception: When the IRA participant's sole beneficiary is a surviving spouse. The surviving spouse has two options unavailable to any other beneficiary. One option is to take withdrawals over the surviving spouse's life expectancy, with the withdrawals starting no later than the year on which the IRA participant would have been 70_. If the surviving spouse was named as the beneficiary, then the spouse can treat the IRA as being his or her own, similar to an IRA rollover. Only a surviving spouse may treat an IRA as a rollover. The surviving spouse then may delay distributions until he or she attains age 70 _.
While the rules have become substantially simpler, there are still questions to be asked and alternatives to consider. For instance, it may be possible to "split" the account before the participant's death, thereby naming several beneficiaries, each of whom may be able to take the distribution based on his or her own life expectancy, following the death of the participant.
Regardless of the simplification, IRAs remain a viable tool for use in establishing a holistic estate plan and should be discussed with your professional at the time the plan is instituted.
The "stretch" IRA is one that names only one beneficiary (a person, not an entity or charity) who elects to retain the decedent-participant's IRA account for that beneficiary's sole benefit. In this case, the beneficiary may elect to continue minimum distribution withdrawals over the IRS table "lifetime" of that beneficiary. In this manner, the account continues to accrue income on a tax deferred basis, with only the minimum distribution withdrawal subject to income tax. REMEMBER: there is no "rollover" (except to a surviving spouse) so the account cannot be transferred to a new account in the beneficiary's name, nor combined with any other IRA account maintained by the beneficiary. REMEMBER, ALSO, if the decedent's estate is subject to estate tax, this account is subject to that tax calculation and any withdrawal from the IRA for that estate tax will "trigger" the income tax on that withdrawal. These funds should be used.
If you would like further information, please contact our office by email or at (650) 470-5300.
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