IRS releases simpler rules for retiree withdrawals

PERSONAL FINANCE

April 28, 2002|By EILEEN AMBROSE

IF YOU LIKED last year's attempt by the Internal Revenue Service to simplify required withdrawals from retirement accounts, you might like the agency's latest efforts even more.

After about a year of taking suggestions on its proposed regulations, the IRS this month released its final rules for mandatory distributions from individual retirement accounts, 401(k)s and similar plans after the account holder turns 70 1/2 .

"It's a little better. It's additional simplification," said Ed Slott, publisher of Ed Slott's IRA Advisor in Rockville Centre, NY.

The rules also reduce the amount that must be withdrawn every year by increasing the average life expectancy of retirees, and provide for financial institutions to help customers calculate distributions.

The government requires minimum withdrawals so it can finally collect ordinary income tax on money that has been squirreled away in tax-deferred accounts for years. (Owners of a tax-free Roth IRA don't have mandatory withdrawals, but those who inherit a Roth do.)

For many years, retirees struggled to take mandatory distributions using 1987 rules that were so complex that many had trouble complying, experts said. Last year, to the relief of many, the IRS proposed a simpler method that retirees could use.

Next year, everyone required to take distributions must use the final rules. But for distributions this year, they can figure withdrawals using the 1987 rules, last year's rules or the just-issued final regulations.

Tax experts say most people will be better off using the latest rules.

"I can't see any reason why they would not," said Stephen J. Silverberg, an estate planning and elder law attorney in Garden City, N.Y.

Under the rules, most people will figure withdrawals using a uniform lifetime table, which assumes their beneficiary is 10 years younger. Those whose beneficiary is a spouse more than 10 years younger will use a different table that calls for smaller withdrawals.

You can take out more than the IRS demands and do so before age 70 1/2 , but many retirees don't need the cash yet and prefer keeping their money growing tax-deferred as long as possible. For them, the final rules offer some benefits.

Here are some of the highlights:

Longer life expectancy: Last year's tax law required that the IRS update its mortality rates. The latest tables add about a year to life expectancy in many cases, thus reducing the size of withdrawals because they are spread over a longer period.

To show the difference that the new mortality rates make, tax information specialist Research Institute of America gives the example of a 75-year-old single person with a $500,000 IRA balance at the end of last year. The annual withdrawal this year would be $22,936 using 2001 rules, and $21,834 under the final rules.

"It doesn't sound like much," said Silverberg. "That's over 4.5 percent in the amount of distribution."

But consider that a grandparent might leave an IRA to a child or grandchild, Silverberg added. "Compound that over a lifetime, and you're going to see numbers that are substantially higher," he said.

Finalizing beneficiaries: People still need to name beneficiaries to retirement accounts, but the new rules give heirs time to do tax planning after an account holder dies.

That's because beneficiaries have up to Sept. 30 of the year after the death of the account holder to determine who will be the final beneficiaries for figuring mandatory distributions.

A new beneficiary can't be added after the account holder dies, but beneficiaries who have already been named can be removed if they disclaim an inheritance or cash out if it means a better tax situation.

For example, Silverberg said, suppose you named a charity and a child as beneficiaries of an IRA. If left unchanged, the distributions would be based on the shortest life span, which in this case would be the charity. In this scenario, distributions would have to be made within five years, which could mean hefty tax bills, he said.

Under the new rules, though, the charity can be paid its share before the Sept. 30 deadline and the child can become the sole beneficiary. Distributions then would be based on the child's longer life expectancy, Silverberg said.

IRA reporting requirements: Beginning next year, financial institutions that are custodians of IRAs must tell customers how much they are required to withdraw, or at least let them know they have to take distributions and offer to calculate the amount for them.

"It will make it even less likely that people will be subject to the penalties for not taking minimum amounts required," said Richard O'Donnell, an editor of RIA's Federal Taxes Weekly Alert in New York.

That penalty is stiff - 50 percent of the amount that should have been taken out.

Also, starting in 2004, financial institutions will have to tell the IRS which accounts are required to take distributions, although they won't have to report the amount.

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