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How to make the new IRA rules work for you The IRS has simplified withdrawal rules on a lot of retirement accounts, but you need to take the right steps to reap their benefits. Here's what to do. By Ginger Applegarth How many ways can you say "you are dead wrong" without offending an audience? That's the dilemma I faced recently when I addressed a large audience of wealthy senior citizens on the new Internal Revenue Service rules for retirement account withdrawals. I tried it with: "Sorry, that's not really the case." And then: "Actually, that's not quite right." And even: "It's a little different than that."
Most of these folks have investment managers and financial advisers, so I was stunned by how little they knew about the new IRS rules and the important planning they need to do now. The tax benefits can be huge, but many of them don't happen automatically -- you have to take action. Here’s a quick summary of what these rules mean for you.
Three scenarios The new rules let you adjust some of your estate planning. How you change things depends on a number of factors. I’m going to outline what you should do under three possible scenarios. (But remember, your needs are unique. So, consult your lawyer or a financial adviser.) You haven't started taking distributions yet, but you still need to do some smart estate planning. Don’t forget to name a beneficiary. Yes, you. The deadline for naming the final beneficiaries is Dec. 31 of the year after you die, but only people or entities (such as a trust) that you've named on your beneficiary form are eligible to inherit. Name at least one beneficiary and several contingent beneficiaries, depending on your situation. That way, the required minimum distribution is based on the life expectancy of your beneficiaries and not your own. Beneficiaries now take money out of the plan based on their own life expectancies at your date of death. If you don't name any beneficiaries, all the money goes in your estate, and it must be distributed within five years after you die. If you don't have a will, it's divvied up according to your state’s laws. If you do have a will, it's divvied up according to your wishes. Keep copies of all beneficiary forms and store them in a safe or your lawyer's office. Financial institutions lose forms all the time; don't take a chance. Name at least one primary beneficiary and one contingent beneficiary. Here’s why: your primary beneficiary (or beneficiaries) can "disclaim" his share so that it can get passed on to the next person. In other words, they say "I don't want the money," so it goes to the next beneficiary in line. This may actually be a better deal for everyone involved for tax purposes. Don't name any of your minor children as direct beneficiaries. Otherwise, they get the pot of gold at age 21 as a lump sum with no spending restrictions. Use a Uniform Gifts to Minors account or a trust such as a testamentary trust. With the right kind of trust, distributions can be spread out over your children’s or grandchildren's entire life expectancies. That could mean more than 50 years for your child and even longer for your grandchild. That's major income tax savings. You have started taking distributions (or will start taking them this year). Do everything in Scenario No. 1. Before you take anything (or another penny) out of your IRA this year, stop! Check the new tables and instructions to see how much you have to take out this year. Subtract what you have already taken (perhaps through quarterly or monthly distributions). The amount left over is the ONLY AMOUNT YOU HAVE TO TAKE. (Obviously, if you need the cash, take it.) Once you’ve calculated the correct amount, take out at least the minimum. Failure to take out the minimum generates a federal excise tax of 50% on the balance not taken out. Plus, you have to pay ordinary income tax on the full amount. Check your withdrawal estimates against those of the financial institution where your account resides. Some experts say that in addition to giving information about your account and your withdrawals to the IRS, your financial institution must tell you how much you must withdraw each year. If their numbers don’t match with yours, get them resolved. You can use the old rules for 2001 and delay using the new rules until 2002, but you’re probably better off with the new rules. See if your 401(k) or related plan has amended its provisions to account for the new withdrawal rules. The plan must amend its provisions for you to use the new rules. If your plan won't adopt the new rules for 2001, and you end up with a bigger distribution this year under the old rules, roll the extra amount into an IRA. It’s just a one-year-only strategy, but it will save you on income taxes. Let’s say you converted your IRA to a Roth to lessen a problem. (A changing family situation, for example.) Now you may want to convert back to a traditional IRA. Under the old rules, converting to a Roth would have let your beneficiaries stretch out their annual distributions based on their life expectancy instead of yours. That’s unnecessary now because they can do so under the new rules anyway. It’s probably best to convert your Roth if the account has substantially fallen in value. The deadline is Oct. 15, 2001, even if you’ve already filed your 2000 return. In that case, you'll get a tax refund. You recently inherited an IRA. If your family is doing postmortem estate planning (and they should), and it makes sense to disclaim, it's not an all-or-nothing proposition -- a designated beneficiary can keep some and disclaim the rest. Even though the deadline for declaring a beneficiary is Dec. 31 of the year after death, a beneficiary only has nine months after the date of death to disclaim. Don't miss the deadline. Split the IRA into separate shares for each beneficiary. That way, each one can take out distributions based on his or her life expectancy. The IRA has to be retitled. But make sure it stays in the original owner's name with you as beneficiary, or you will get hit with huge excise and income taxes. If an estate tax was paid on the IRA (even if the cash didn’t come out of the account), you can take an itemized deduction for your share. That payment can offset the income you take out of the IRA each year. If the deduction exceeds your income, it’s used up in successive years until gone. Be sure to name any successor beneficiary so that distributions can be stretched out over your life expectancy, instead of having the entire IRA account distributed and taxed immediately. It's not just for IRAs We think of this as just applying to IRAs, but that's not the case. In fact, it also applies to 401(k) s, 403(b)s and all qualified plans. The exceptions are fixed annuities and defined-benefit plans that pay a fixed annual amount. The rules can get complicated when dealing with 401(k) and Keogh plans, especially if you are married. In fact, there are different rules and strategies for the different retirement plans, but it's important to remember that the IRS has given us the gift of being able to defer current income taxes and let that money grow tax-sheltered for a very long time. It's best not to look any gift horse in the mouth -- especially when the IRS so rarely offers gifts. Chances are, these new rules apply to you, your loved ones and your friends, so pass the word and help save taxes for everybody. How to calculate your minimum required distribution. Let’s say you have $100,000 in an IRA that yields 6% a year and now must take minimum required distributions. Here’s how you calculate your distribution under new Internal Revenue Service rules. Take the IRA balance from the end of the prior year, then divide it by the combined life expectancy of yourself and your beneficiary from the table below. Here’s how the new formula will work along with how your balance changes over the years.
Source: MSN Money research from IRS data
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