New and Improved Minimum Distribution Rules for IRAs

Attention retirement-account holders! Attention those of you who might inherit these accounts! Recent changes to the rules on taking money out of individual retirement accounts and self-employment-plan IRAs will simplify your life and save you money! Here's why and how:

By law, everyone who owns an IRA must begin withdrawing money from them after turning 70 1/2 or run the risk of stiff penalties. (Many older people who can afford to live off other income and assets want to take out as little as possible from their IRAs, letting the rest grow tax-deferred. The government, however, doesn't want to let people shelter this money from taxes forever, so it forces older folks to begin withdrawing money and paying taxes on it.0

Q: When do the new IRA withdrawal rules take effect?
A: As of January 1, 2001, you are allowed to use either the new rules or the old rules. Beginning January 1, 2002, you must use the new rules. If you have already begun withdrawing from your IRA under the old rules, you can switch to the new rules at any time during 2001.
 

The new rules, which affect the size of these withdrawals -- known in financial jargon as required minimum distributions or RMDs -- simplify the process for figuring out how much you must cash out each year and allow people to keep more money in their IRAs if they so choose.

Before these new rules, which took effect on January 1, there were eight ways you could calculate the RMD, depending on the desired result. And if you wanted to leave your heirs as much as possible, you could select an account beneficiary who was considerably younger than yourself and calculate the withdrawal based on that person's lifetime rather than yours. But when you died, your beneficiary was confronted with complex rules on required distributions from the inherited account.

Understanding all these rules and deciding which set of calculations to use was often beyond the layperson, who had to rely on expert advice. Many people simply accepted the simplest computations, which generally meant they were paying more tax than they had to.

But now, believe it or not, the IRS has simplified the rules considerably. No longer will you have to take the age of your beneficiary into account or hassle with eight equally confusing ways of calculating the RMD. No more confusion about distributions if you inherit an IRA.

And the new rules are bound to save many people money, in the form of smaller withdrawals and smaller tax payments. For instance, under the old rules, a person 71 years old with an IRA worth $250,000 would have to withdraw $16,339. But under the new rules they would only have to withdraw $9,881, a difference of more than $6,400. At a tax rate of 28 percent, the lower withdrawal saves more than $1,800 on annual tax payments and leaves the $6,400 growing tax-free in the IRA. (The difference stems from different life-expectancy figures: 15.3 years under the old rules and 25.3 years under the new rules.)

There are only two things you need to know to take advantage of these new rules: your age as the account holder and the age of your spouse, if he or she is the beneficiary.

After you turn 70 1/2. Each year, look up your age in this minimum distribution incidental benefit (MDIB) table and find the life-expectancy number next to it. Divide your IRA account balance (as of the end of the previous year) by this number. Result: your RMD for that year.

If your sole beneficiary is a spouse who is more than 10 years younger than you, you can opt to use a joint life expectancy table to get an even lower RMD. You can find this table in Appendix E here. General information on IRAs can be found in IRS Publication 590.

When you inherit an IRA. The IRS has also simplified the inheritance rules for IRAs. Under the new regulations, minimum distributions of inherited IRAs are based on the life expectancy of the beneficiary, who doesn't have to be designated until Dec. 31 of the year after the account holder's death.

This extra time allows heirs and executors to make adjustments to the estate plan even after the IRA owner's death. For example, an older beneficiary can disclaim the inherited IRA, allowing it to pass to a younger beneficiary, to achieve a lower RMD. A co-beneficiary can cash out, leaving the other beneficiaries free to use their life expectancies to reduce the RMD. Or the IRA could be divided into separate accounts for each beneficiary with a different life expectancy.

So why has the IRS handed IRA owners such a windfall? Is everything sweetness and light at the kindler, gentler IRS? Not really. In the past, because of the complexity of the RMD calculations, there were no requirements that the account custodian report to the IRS each year regarding your account balance and your required minimum distributions. The IRS could make sure you were following the rules only by auditing your return. Under the new rules, retirement account custodians will be required to compute and report RMDs to you and to the IRS each year, making it much easier for the IRS to be sure you are making the required withdrawals, and to assess a steep 50 percent penalty if you are not. My advice: Be sure you follow the new rules. The IRS is checking up on you.

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