Media Coverage

New Retirement Plan Distribution Rules Provide Flexibility

Printed December, 2001, Business Opportunities Journal
By – J. Graydon Coghlan – Coghlan Financial Group, Inc.

In January, the Internal Revenue Service took action to simplify the regulations that govern how much money people over the age of 70 1/2 and beneficiaries must withdraw each year from tax-deferred retirement accounts, such as Individual Retirement Accounts (IRA’s) and 401(k) plans.

For many retirees, the changes will lower the annual amount they need to withdraw, allowing more of their assets the opportunity to continue growing tax-deferred and lowering their annual tax liability. For those who stand to inherit the assets, the changes bring more ways to spread out the distributions over a number over a number of years and reduce taxes on the assets.

Distribution rule changes

While the regulations are complex we’ll examine three changes here:

Single method of calculating mandatory lifetime distributions.

Until the IRS issued the new re-proposed regulations, people had to choose between six methods of calculating required minimum distributions from retirement accounts that are mandated for account holders once they reach age 70 1/2. The methods were based on a life expectancy factor that involved both the account holder’s and the beneficiary’s age.

The new re-proposed regulations substitute a single method using a table that is based on the joint life expectancy of the account holder and hypothetical beneficiary who is 10 year younger than the account holder. This method is used regardless of whether or not the account holder whose sole beneficiary is a spouse who is more than then years younger than the account holder. In that case, actual joint ages can be used for the calculation, producing an even smaller required minimum distribution.

The standard table is the minimum incidental benefit life expectancy table, known as the MDIB table. Using this standard table, a person will divide the account balance as of the end of the prior year by the life expectancy factor to arrive at each year’s required minimum distribution.

For many people the new calculation method will result in lower required minimum distributions. Because withdrawals are taxed as regular income, many people will benefit from a smaller tax bill on the lesser distribution each year as well. In addition, assets that remain in the account will continue to qualify for tax-deferred growth.

Flexibility in designating a beneficiary.

Previously, the calculation method, based on the eldest beneficiary named on the account, was an irrevocable decision. Now, because distribution calculations are no longer linked to a designated beneficiary, an account’s beneficiary can be changed at any time without an adverse effect on the required minimum distribution amount.

New choices with inherited accounts.

The regulations allow new flexibility for beneficiaries to extend an account’s tax-deferred benefits. For accounts that pass to a spouse, payments continue using the spouse’s single life expectancy. For beneficiaries other than a spouse, separate inherited accounts can be distributed according to each beneficiary’s single life expectancy. These new rules generally allow beneficiaries to maintain a tax-deferred account over a greater number of years than before.

If an account has no designated beneficiary and the account holder dies after starting to take required minimum distributions, the assets will be paid out over the account holder’s remaining life expectancy reduced by one year each year. If an account has no beneficiary and the account holder dies before required minimum distributions start, the balance may be paid out over five years.

It is important to follow these IRS regulations carefully. For those who take out less than the required minimum distribution amount each year after 70 1/2, the IRS continues to assess a 50 percent penalty tax on the amount that should have been distributed.

Need to follow new rules

Although these new regulations don’t take effect until January 2002, the IRS is allowing account holders to use the new calculation method for calendar year 2001 required minimum distributions if they choose, regardless of the terms of their IRA documents.

If, however, you participated in an employer-sponsored retirement account, like a 401(k) plan, you cannot use the new regulations until your plan provider amends the appropriate documents. You’ll want to talk with your legal or tax advisor to see when and whether you should take advantage of these new distribution rules.