| Pension & Retirement / Important IRA Choices Must Be Made by Required Beginning Date |  |
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Most workers used to get a monthly
pension at retirement and weren't responsible for investment or tax
decisions related to it. Now, however, with 401(k) and other individual
account plans being the norm, employees often take complete charge of
their accounts, making most investment decisions. At retirement, plan
participants often transfer their benefits from employer plans to IRAs.
As a result, they become responsible for setting things up to take
required distributions from the IRAs. Owners of traditional IRAs must
begin to take required minimum distributions by April 1 following the
year in which they turn age 70-1/2. The required beginning date is more
than just the deadline for the start of plan payouts. It is also the
date by which two very important choices have to be made: (1) the method of calculating
required distributions, and (2) the naming of a designated
beneficiary. Unfortunately, people often make
these decisions by filling out a form at a financial institution without
understanding the implications of their choices and without seeking
professional advice. This letter might help to keep you from making the
same mistake. It's meant to help you understand more about the important
choices you will have to make in handling distributions from your IRA. Two calculation methods:
IRA owners can choose between two basic methods in figuring their
required minimum distributions: (1) the term-certain method, and (2) the annual recalculation method. Under the term-certain method,
distributions for the first year are figured using the account owner's
life expectancy (or the account owner and designated beneficiary's joint
life expectancy) from tables in IRS regulations. In each succeeding
year, distributions are figured by subtracting one from the originally
determined life expectancy. Thus, distributions will not extend beyond
the originally determined life expectancy. Under the recalculation method, the
life expectancy tables in the IRS regulations must be used each year to
determine the account owner's life expectancy (or the account owner and
beneficiary's joint life expectancy) instead of subtracting one year
from the originally determined life expectancy. The recalculation method
results in a longer payout period, because the longer a person lives,
the higher his chances are of living longer than the originally
determined life expectancy. So using the recalculation method spreads
out the payout period and results in smaller distributions being
required in any given year. This leaves more funds in the IRA to
continue to grow tax-deferred. That fact, however, can lead some
people into a potential trap. Although the annual recalculation method
seems to maximize the payout period, it generally should be used only
by those who are relying on their IRA assets as a primary source of
support, and whose main objective is to ensure that they don't outlive
their IRA distributions. The reason is that it can lead to
accelerated payouts following the death of the IRA owner. This puts an
end to the IRA's tax deferral, and may push the beneficiary or estate
into a higher income tax bracket. With the term-certain method,
distributions after the account owner's death can continue at the same
rate as before death. This keeps the IRA's tax deferral going for the
beneficiaries and spreads the income recognition out over a number of
years, possibly resulting in it being taxed at a lower rate than if it
must be paid out in one year. Selecting a designated beneficiary:
A designated beneficiary is an individual who is entitled to a
portion of an IRA owner's account, contingent on the IRA owner's death
or another specified event. (Individual beneficiaries of certain trusts
named as IRA beneficiaries also may be designated beneficiaries.)
Required minimum distributions may be taken over the account owner's
life or the lives of the account owner and a designated beneficiary, or
over a period not extending beyond the life expectancy of the account
owner or of the account owner and a designated beneficiary. Without a
designated beneficiary, minimum distributions can't be spread over a
period longer than the account owner's life or life expectancy. If an IRA owner dies before required
minimum distributions have begun without naming a designated
beneficiary, the entire plan balance must be distributed within five
years after the year of his death. However, if any part of the IRA is
payable to a designated beneficiary, that part may be distributed over
the designated beneficiary's life or life expectancy, provided
distributions begin by the end of the year following the year of death. If an IRA owner dies before
required distributions have begun and his spouse is the designated
beneficiary, the surviving spouse may begin distributions under the
above rule by the end of the year following the decedent's death, or
defer required distributions until the end of the year during which the
decedent would have turned age 70-1/2. In this situation, a surviving
spouse also may treat the IRA as her own, allowing her to use her own
required beginning date and to name her own beneficiaries. If an IRA owner dies after
beginning required distributions, his remaining account balance must be
distributed at least as rapidly as under the method of distribution that
was being used until then. The bottom line is that naming a designated beneficiary for an IRA keeps IRA tax-deferrals going for a longer—sometimes a much longer—period of time. Ultimately, this increased tax advantage results in more earnings being generated by the IRA. |
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